Essays on Risk Finance and Incentive Contracting

Abstract

This thesis consists with three topics. Chapter 1 Incentive Contracting with an Independent Underwriter: Does It Benefit Insurers? proposes an analytical model to investigate the decision factors of an insurance company when choosing between direct writing and independent underwriter as distribution channel. It also explores the impact of contingent commissions on the underwriting performance of insurance companies. To count for the impact of policy renewal, this paper measures the difference of underwriting performance between using independent underwriter and direst writing in the single-period model, as well as in the multi-period model. It is found that the key decision factors of distribution system include: underwriting risk, underwriting task complexity, underwriting cost, as well as policy renewal. Chapter 2 Risk Finance for Catastrophe Losses with Pareto-Calibrated Levy-Stable Severities proposes a risk finance paradigm for catastrophe losses. The conventional risk finance paradigm of enterprise risk management identifies transfer, as opposed to pooling or avoidance, as the preferred solution. However, this analysis does not necessarily account for differences between light- and heavy-tailed characteristics of loss portfolios. Of particular concern are the decreasing benefits of diversification (through pooling) as the tails of severity distributions become heavier. In the present article, a loss portfolio characterized by nonstochastic frequency and a class of Lévy-stable severity distributions calibrated to match the parameters of the Pareto II distribution is investigated. Then a conservative risk finance paradigm is proposed. It can be used to prepare the firm for worst-case scenarios with regard to both (1) the firm's intrinsic sensitivity to risk and (2) the heaviness of the severity's tail. Chapter 3 A Risk-Based Risk Finance Paradigm proposes an alternative to the conventional risk finance paradigm of enterprise risk management that accounts for not only a loss portfolio's expected frequency and expected severity, but also its "risk" as captured by an appropriate measure of dispersion/spread. This new paradigm is based upon four distinct properties of a loss portfolio that enhance the benefits of diversification: (1) a high expected frequency; and (2) less than perfect positive correlations between individual severities; (3) light-tailed severities; and (4) a predictable (i.e., non-erratic) frequency.