Contingent Commissions and Market Cycles

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Contingent Commissions and Market Cycles

• Paper by
• Lan Ju, UWI, Madison
• Mark J. Browne, UWI, Madison
• Discussed by
• Puneet Prakash, VCU, Richmond

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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

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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.

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Strengths of the paper

• Idea itself
• Literature Review
• Grace and Hotchkiss (1995)

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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

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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

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References

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