Enhanced pricing and management of bundled insurance risks with dependence-aware prediction using pair copula construction

Peng Shi and Zifeng Zhao

Journal of Econometrics, 2024, vol. 240, issue 1

Abstract: We propose a dependence-aware predictive modeling framework for multivariate risks stemmed from an insurance contract with bundling features — an important type of policy increasingly offered by major insurance companies. The bundling feature naturally leads to longitudinal measurements of multiple insurance risks, and correct pricing and management of such risks is of fundamental interest to financial stability of the macroeconomy. We build a novel predictive model that fully captures the dependence among the multivariate repeated risk measurements. Specifically, the longitudinal measurement of each individual risk is first modeled using pair copula construction with a D-vine structure, and the multiple D-vines are then integrated by a flexible copula. While our analysis mainly focuses on multivariate insurance risks, the proposed model indeed contributes to the broad research area of longitudinal data analysis. In particular, it provides a unified modeling framework for multivariate longitudinal data that can accommodate different scales of measurements, including continuous, discrete, and mixed observations, and thus can be potentially useful for various economic studies. A computationally efficient sequential method is proposed for model estimation and inference, and its performance is investigated both theoretically and via simulation studies. In the application, we examine multivariate bundled risks in multi-peril property insurance using proprietary data from a commercial property insurance provider. The proposed model is found to provide improved decision making for several key insurance operations. For underwriting, we show that the experience rate priced by the proposed model leads to a 9% lift in the insurer’s net revenue. For reinsurance, we show that the insurer underestimates the risk of the retained insurance portfolio by 10% when ignoring the dependence among bundled insurance risks.

Keywords: Multivariate longitudinal data; Copula; D-vine; Insurance operations; Predictive analytics; Graphical model (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:econom:v:240:y:2024:i:1:s0304407624000228

DOI: 10.1016/j.jeconom.2024.105676

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