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Contingent Commissions and Market Cycles

Contingent Commissions and Market Cycles. Paper by: Lan Ju, UWI, Madison Mark J. Browne, UWI, Madison Discussed by: Puneet Prakash, VCU, Richmond. Main Idea. Profit based contingent commission mitigates the effect on underwriting cycle Process: Monitoring role of producers

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Contingent Commissions and Market Cycles

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  1. Contingent Commissions and Market Cycles Paper by: Lan Ju, UWI, Madison Mark J. Browne, UWI, Madison Discussed by: Puneet Prakash, VCU, Richmond

  2. Main Idea • Profit based contingent commission mitigates the effect on underwriting cycle • Process: • Monitoring role of producers • Competitive bidding reveals mispricing errors to producer • Profit based contingent commission provide an incentive to steer away business from insurers who under price

  3. Test using 2SLS • Loss Ratio Development (LRD) = F (Con Comm, Risk, Investment Experience, Premium growth, controls) • H0: Sign on Con Comm is negative and significant • Evidence in support of H0.

  4. Strengths of the paper • Idea itself • Literature Review • Grace and Hotchkiss (1995)

  5. Some Technical issues • Sample: Consists of only firms with positive growth in premiums earned . Why? • Theoretical argument: In favor of simultaneity, yet no LRD as independent variable in 1st stage regression • IV estimation: Some canned procedures correct for s.e.; some do not • IV estimation: Need one exogenous variable correlated to 1st stage equation, but not correlated to main dep var LRD

  6. Suggestions- Technical • Heckman procedure instead of Tobit • Hausman Test on endogeneity • Geographic Herfindahl • 3 year LRDs as in Harrington, Danzon, Epstein (2005) • Speed of claims – OECD committee guidelines • Increase sample size

  7. References • Grace, M.F. and Hotchkiss J.,1995, JRI • Pagan, A., 1984, IER • Pagan, A., 1986, RES

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