Changes in the Life Insurance Industry: Efficiency, Technology and Risk Management

Transcription

1 Changes in the Life Insurance Industry: Efficiency, Technology and Risk Management

2 INNOVATIONS IN FINANCIAL MARKETS AND INSTITUTIONS Editor: Mark J. Flannery University of Florida Gainesville, Florida, U.S.A. Other books in the series: England, C. and Huertas, T.: THE FINANCIAL SERVICES REVOLUTION Gup, B.: BANK MERGERS: CURRENT ISSUES AND PERSPECTIVES Kormendi, R., Bernard, V., Pirrong, S., and Snyder, E.: CRISES RESOLUTION IN THE THRIFT INDUSTRY Hancock, C.: A THEORY OF PRODUCTION FOR THE FINANCIAL FIRM England, G.: GOVERNING BANKING'S FUTURE Kaufman, G.: BANKING STRUCTURES IN MAJOR COUNTRIES Anderson, S., and Born, J.: CLOSED-END INVESTMENT COMPANIES Anderson, S., Beard, T.R., and Born, J.: INITIAL PUBLIC OFFERINGS: FINDINGS AND THEORIES Cottrell, A.F., Lawlor, M.S., and Wood, J.H.: THE CAUSES AND COSTS OF DEPOSITORY INSTITUTION FAILURE Barron, J.M., and Staten, Michael E.: CONSUMER ATTITUDES TOWARD CREDIT INSURANCE

3 Changes in the Life Insurance Industry: Efficiency, Technology and Risk Management edited by J. David Cummins Department of Insurance and Risk Management The Wharton School The University of Pennsylvania Anthony M. Santomero Department of Finance The Wharton School The University of Pennsylvania ~. " Springer Science+Business Media, LLC

4 Library of Congress Cataloging-in-Publication Data Changes in the Iife insurance industry: efticiency, technology, and risk management / edited by 1. David Cummins and Anthony M. Santomero. p. cm. -- (Innovations in tinancial markets and institutions) The tindings of a multi-year study initiated by the Wharton Financial Institutions Center in 1995, and reported in 10 chapters by the editors and other researchers. Inc1udes bibliographical references. ISBN ISBN (ebook) DOI / Insurance, Life -- United States. 1. Cummins, J. David. II. Santomero, Anthony M. III. Series. HG8951. C ' dc CIP Copyright 1999 by Springer Science+Business Media New York Originally published by Kluwer Academic Publishers in 1999 Softcover reprint of the hardcover 1 st edition 1999 Second Printing AII rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher, Springer Science+Business Media, LLC. Printed on acid-free paper. This printing is a digital duplication of the original edition.

5 Contents Contributing Authors vii 1 Life Insurance: The State of the Industry Anthony M. Santomero 2 The Industry Speaks: Results of the WFIC Insurance Survey 19 James F. Moore and Anthony M. Santomero 3 Efficiency in the U.S. Life Insurance Industry: Are Insurers Minimizing Costs and Maximizing Revenues? 75 J. David Cummins 4 Efficiency and Competitiveness in the U.S. Life Insurance Industry: Corporate, Product, and Distribution Strategies 117 Roderick M. Carr, J. David Cummins, Laureen Regan 5 Life Insurance Mergers and Acquisitions 159 J. David Cummins, Sharon Tennyson Mary A. Weiss 6 Strategy, Human Resource Management, and the Performance of Life Insurance Firms 187 Clint Chadwick and Peter Cappelli 7 The Impact of the Information Technology Management Practices on the Performance of Life Insurance Companies 211 Lorin M. Hitt

6 vi 8 Toward a Unified Valuation Model for Life Insurers David F. Babbel and Craig Merrill 9 An Analysis of the Financial Risk Management Process Used by Life Insurers David F. Babbel and Anthony M. Santomero 10 Challenges and Issues for Growth in the Life Industry Michael R. Tuohy Index CONTENTS

7 About the Authors David R Babbel joined the Wharton School faculty in 1984 and currently is professor of insurance and finance. He teaches in the graduate program primarily in the areas of insurance finance and investment management. Prior to joining Wharton, he was on the finance faculty for seven years at the University of California at Berkeley, where he taught principally in the areas of international financial management, corporate finance and investments. A former vice president and director of research in the pension and insurance department of Goldman, Sachs & Co., and economist at the World Bank, he is a financial consultant for several of the largest financial institutions. He has published prolifically in academic and professional literature on asset/liability management, insurance, fixed income investments, and foreign exchange risk management. He is co-author of a 1996 monograph, "Valuation of Interest-Sensitive Financial Instruments." He received his undergraduate training in economics at Brigham Young University, and his graduate training at the University of Florida in finance. His postdoctoral education in insurance was undertaken at the University of Pennsylvania's Wharton School. Peter Cappelli is a professor of management at the Wharton School and director of the Center for Human Resources, University of Pennsylvania. He received a DPhil at the University of Oxford in 1983 and a B.S. degree from Cornell University in He has been the chairperson of the management department at the Wharton School and currently serves as co-director of the U.S. Department of Education National Center on the Educational Quality of the Workforce at the University of Pennsylvania.

8 viii ABOUT THE AUTHORS Before joining the Wharton School faculty in 1985, he held appointments at the University of California at Berkeley, University of Illinois, and Massachusetts Institute of Technology. His primary areas of research are human resource compensation issues, labor economics and union-management relations. Currently he is completing a major study of the changing employment contract in the Unite State. Roderick M. Carr has been the deputy governor of the Reserve Bank of New Zealand since July In this role, he is responsible for the Reserve Bank's operations, payments systems operation and financial system oversight, and is a member of the Reserve Bank's Board of Directors. Prior to joining the Reserve Bank, he held senior management positions in the global payments area of the National Australia Bank in Melbourne. From 1994 to 1997, while completing his doctoral studies, he was Research Fellow and a Project Director at the Wharton Financial Institutions Center in Philadelphia. Previously, he served as chairman and manager of the Ministerial Committee on the Funding and Provision of Health Services for the New Zealand government. He was chief manager of retail financial services and general manager of BNZ Life Insurance Ltd. before going overseas. He holds a Ph.D. and M.A. from the Wharton School, University of Pennsylvania, an M.B.A. from Columbia University's Graduate School of Business in New York, and an L.L.B. (Hons) from the University of Otago. J. David Cummins is the Harry 1. Loman Professor of Insurance and Risk Management at the Wharton School of the University of Pennsylvania and Executive Director of the S.S. Huebner Foundation for Insurance Education. His fields of specialization include financial risk management of insurance firms and the economic analysis of efficiency and productivity. Dr. Cummins has written or edited fifteen books and published more than fifty refereed journal articles in publications such as the Journal of Business, Journal of Finance, Management Science, the Journal of Banking and Finance, the Journal of Financial Intermediation, the Journal of Economic Perspectives, the Journal of Risk and Insurance, the Journal of Risk and Uncertainty, the Journal of Productivity Analysis, and the Astin Bulletin. He has received eighteen prizes for his journal articles including the prize as best financial paper at the Centennial Meeting of the International Actuarial Association, Brussels, Belgium, in 1995, the Brian Hey Prize for best

9 ABOUT THE AUTHORS ix financial paper by the Institute of Actuaries (UK.), in 1998, Alpha Kappa Psi-Spangler Prize, the Robert C. Witt Award, and several Journal of Risk and Insurance articles awards. Dr. Cummins has served as consultant to numerous business and governmental organizations including IBM, CIGNA, Liberty Mutual, the National Association of Insurance Commissioners, the Alliance of American Insurers, the US. Department of Justice, and the Internal Revenue Service. He is a past-president of the American Risk and Insurance Association, has served as editor of the Journal of Risk and Insurance and as Visiting Scholar at the Federal Reserve Banks of Atlanta and Philadelphia, and currently is Associate Editor of seven refereed journals. He received his Ph.D. from the University of Pennsylvania in 1972, M.A. from the University of Pennsylvania in 1971, and B.A. from the University of Nebraska in Lorin M. Hitt is assistant professor of operations and information management at the Wharton School, University of Pennsylvania. He received a Ph.D. from Massachusetts Institute of Technology, 1996, an M.S. from Brown University in 1989, and an Sc.B. from Brown University in He joined the Wharton School faculty in His primary research areas include information technology and productivity, information systems and organization, economics of information, and applied econometrics. Presently, he is engaged in contract structure for IS outsourcing and in measuring the productivity effects of information systems. He is currently involved in an empirical investigation on the relationship between organizational practices, information technology, and productivity. He is investigating the role of firm structure on the value of information systems investments, and optimal contract structure for IS outsourcing arrangements. Craig Merrill is an assistant professor of finance and the Grant Taggart Fellow of Insurance and Risk management at the Marriott School of Management at Brigham Young University. He received his Ph.D. in insurance from the Wharton School of the University of Pennsylvania. His primary area of academic research and publication is the valuation of interestrate contingent securities with applications to derivative pricing, modeling of default risk, and valuation of insurance liabilities. One of his monographs on financial valuation models was commissioned and published by the Society of Actuaries, and is used in their certification exams. Others of his papers, on financial valuation models for life insurers, which

10 x ABOUT THE AUTHORS he has co-authored with David Babbel, are a key part of the effort of the American Academy of Actuaries' efforts to implement a unified valuation system for life insurers. He has also conducted research and published on investment strategy and loss distribution models. His consulting assignments (AIG, Goldman Sachs, Lazard Freres, Winkelvoss & Associates, New York Life, and others) have involved such projects as a two-factor bond pricing model, multi-asset return simulation models, compiling a database of intraday Treasury security prices based on the GovPX data feeds, and development of international interest-rate and exchange-rate simulation models. He has also presented professional seminars on risk management, mathematical finance, and financial pricing of insurance liabilities. James F. Moore is a senior research fellow with the Wharton Financial Institutions Center and a consultant to Enhance Financial Services. His research spans a wide variety of insurance related topics including retirement savings behavior, pricing of catastrophic risk, and the role of insurers as financial intermediaries. He currently is exploring parallels between pricing and risk analysis in the catastrophic and credit risk arenas. Prior to pursuing graduate study, he worked for William M. Mercer where he focused on asset-liability management for pension plans and post-retirement medical plans. He has a Ph.D. and M.A. from the Wharton School of the University of Pennsylvania and a B.S. from Brown University. Laureen Regan is an assistant professor in the department of risk management and insurance at the Fox School of Business in Temple University. Her research interests are in property-liability insurance industry market structure. She earned her Ph.D. from the Wharton School in December 1993, and has published articles in the Journal of Risk and Insurance, and the Journal of Law and Economics. Anthony M. Santomero is the Richard K. Mellon professor of finance and the director of the Financial Institutions Center at the Wharton School of the University of Pennsylvania. He is a leading authority on financial institution risk management and financial structure and a recognized consultant to major financial institutions and regulatory agencies throughout North America, Europe, and the Far East. His studies into the effects of capital regulation have influenced the way regulators around the world control the industry, and his examination of risk management systems continues to pioneer new approaches and techniques in this area as well.

11 ABOUT THE AUTHORS xi As a consultant for leading financial institutions in the Unite State and abroad, he has addressed issues of financial risk management procedures, the pricing of risk of various kinds, and credit risk evaluation and management. He has advised the Federal Reserve Board of Governors, the FDIC and the General Accounting Office on a wide range of issues relating to capital regulation and structural reform. Internationally, he has been a consultant to the European Economic Community in Brussels, the Inter American Development Bank, the Kingdom of Sweden, the Ministry of Finance of Japan, the Treasury of New Zealand, the Bank of Israel, the National Housing Bank of India, the Saudi Arabian Monetary Agency, and the Capital Markets Board of Turkey. In addition, he currently serves as a permanent Advisor to the Swedish Central Bank. He is associate editor of seven academic journals, including the Journal of Money, Credit and Banking, Journal of Financial Services Research, and Journal of Banking and Finance. He has written more than 100 articles and monographs on financial sector regulation and economic performance, including one of the first studies to analyze the behavior of banks in Japan. He received his A.B. in economics from Fordham University in 1968, his Ph.D. in economics from Brown in 1971, and received an honorary doctorate from the Stockholm School of Economics in Sharon Tennyson is associate professor of policy analysis and management at Cornell University. She holds a Ph.D. degree in economics from Northwestern University with a specialization in industrial organization and public policy, and was previously on the faculty of the department of insurance and risk management at the Wharton School of the University of Pennsylvania. Her professional career has focused on economic and policy issues in insurance markets, most notably automobile insurance regulation, insurance fraud, and insurance distribution. Her work has been published in economics, insurance and finance journals, and she has received research funding from a variety of sources. Her current research initiatives include claiming behavior and claims payment practices in automobile insurance, the impact of institutional arrangements on insurance regulatory outcomes, and consumer shopping and purchase behaviors in insurance markets. Michael R. Tuohy is managing director of Tillinghast Towers-Perrin. He joined the firm in 1973 to establish the London office. In 1977, he became head of the Atlanta office's life insurance consulting operations. In 1984, he moved from Atlanta to head up the firm's New York offices. In 1988, he was

12 xii ABOUT THE AUTHORS chosen to lead the firm's joint venture with Towers Perrin's general management practice. In October 1989, he became head of Tillinghast-Towers Perrin's life insurance practice. He was appointed the firm's managing director in March He has extensive experience not only in the United States and the United Kingdom, but also in Australia, Canada, South Africa, and several European countries. His consulting background includes work in the areas of life insurance company acquisitions, strategic planning, product development, and financial reporting and measurement, with particular emphasis on the creation of meaningful reports to management. He received a B.A. from Oxford University. He is a Fellow of the Institute of Actuaries, an Associate of the Society of Actuaries, a member of the American Academy of Actuaries and a Fellow of the Conference of Consulting Actuaries.

13 Changes in the Life Insurance Industry: Efficiency, Technology and Risk Management