TheNatureoftheLossRatioinProperty-CasualtyInsurance.pdfVIP

The Nature of the Loss Ratio in Property-Casualty Insurance Peter M. Ellis* Abstract: The aggregate loss ratio in the United States stock property-casualty insur- ance industry is represented with an autoregressive AR(3) model. It is demonstrated with a Monte Carlo simulation that the loss ratio is quite unstable. Annual growth has been strong for both premium volume and losses, but the loss ratio is found to fluctuate unsteadily as an AR(3) process. Also, there is a continuing upward drift to the loss ratio that cannot continue without bringing failed loss coverage to the industry. INTRODUCTION nsurers, regulators and the public have a clear and continuing interest I in preserving the viability of the insurance enterprise. Insolvencies almost certainly subject policyholders to financial chaos. Regulators are required to protect insureds from this calamity. The insurers also clearly wish to have excellent financial health. It is therefore necessary for the insurance enterprise to experience either underwriting gains or minimal losses. However, the total loss and expense ratio in property-casualty insurance is often in excess of 1.0 (Best’s Aggregates and Averages, various years), indicating that underwriting activity has been carried out at a loss. This may be acceptable even if it continues for years because investment gains have generally been steady and consistent. They historically have been relied upon to more than offset any underwriting loss. Fairly (1979) carried out an excellent analysis of underwriting gain or loss in property-casualty insurance. He invoked the capital asset pricing * Department of Business Administration, Utah State University, Logan, UT, 84322-3510, 801- 797-2372. Journal of Insurance Issues, 1998, 21, 1, pp. 46–62. 46 Copyright ? 1998 by the Western Risk and Insurance Association. All rights reserved. LOSS RATIO IN PROPERTY-CASUALTY INSURANCE 47