My Experience with Insurance Co.

[buells]

Played a game with insurance companies for the first time, and I have to say, it has been implemented quite nicely. I am using version 6.4.10.

Only things that have been issues are:

1. Even though the insurance company was very well equitized (>25% equity capital), the holding company stock price reacted in an extreme fashion to large negative net income. Come to think of it, it probably overreacted on the positive side as well when things recovered. Investors should probably look more at a normalized net income that assumes an average ROE over time based on a normalized ROI to determine appropriate P/B and keep P/B reasonably constant over time. Just taking raw unadjusted earnings and slapping a P/E on that results in crazy volatility, totally defeating the purpose of mark-to-market earnings.

2. It is hard to track the performance of the insurance company's portfolio. The summary ROE metric is okay, but it would be good to be able to see total realized and unrealized gain on stocks and bonds + combined. Investment performance is a critical driver of success. Other useful metrics would be current average dividend yield on your equity portfolio and current average YTM on your bond portfolio.

3. When your insurance company runs out of cash but still has investment assets, the pop-up screen should let you choose to go to stock/bond market screen or fund transfer screen. It shouldn't be automatically just the fund transfer screen since you can just sell some assets to keep it cash positive so long as it has adequate reserves.

4. An insurance company in my game collapsed leaving the HoldCo with deeply negative net assets on its balance sheet, but it seems like it isn't ever responsible for actually settling the claims (i.e., the company isn't bankrupt or losing cash, it is just sitting there). It seems like it should go bankrupt as the negative net assets would be like a bond coming due if the regulators forced a resolution or otherwise the claims would just need to be paid out over time somehow. There could be something more complex going on I don't understand.

5. There's a bug limiting the amount of bonds you can buy at once using your insurance company. It limits it to the amount of cash on the HoldCo balance sheet, which doesn't make sense. (You can also wind up buying too many bonds if HoldCo cash is greater than Insurance Co. cash).

6. Claims--I am still a bit confused about how these are presented. My understanding is you have a claims reserve for long tail policies like life insurance. I believe the reserve should change based more or less on the following formula:

Beginning Claims Reserve (This is a Credit Account on BS)
+ Reserve for New Policies (Credit Reserve, Debit Expense)
+ Accretion of Claims Reserve (Credit Reserve, Debit Expense)
+/- Change in Actuarial Assumptions (Credit/Debit Reserve, Credit/Debit Income/Expense)
- Claims Paid (Debit Reserve, Credit Cash)
Ending Claims Reserve

You reserve for new policies based on the present value of expected claims. You increase the reserves on existing policies by the discount rate over time (similar to the effect of amortization of a bond discount). Actuarial assumptions are updated on a regular basis to reflect changing expectations of future claims based on new evidence and changing discount rates (this could be simulated by randomly varying the assumed timing of future claims and varying the discount rate used to PV those yields according to the broader in-game interest rate). When claims come due, cash is paid out and the related reserve is extinguished (for life insurance... I suppose for other lines it might work a bit differently).

I think perhaps the current simulation deals with this well, but I want to know if the reserve accretes over time, which I think is important, and if claims vary randomly. With life insurance, the total dollar amount of future claims shouldn't vary, but I suppose the weighted average timing of them might. Changing interest rates have a huge impact on the liability side of insurance company balance sheets (higher interest rates decrease liabilities and lower interest decrease them). That's why they need to hold a portfolio of assets with a similar weighted average duration to their claims liabilities or otherwise hold a fair amount of excess capital.

7. What does the "Loan Interest Rate" mean at this point? Does it relate to bond yields and deposit/bank loan interest rates? Why are Treasury Yields presented as 2.75% when the Loan Interest Rate is 6.75%? I play with inverse inflation on, so it can be hard to understand what figures are nominal and which are real. I believe the yields are presented in real terms when inverse inflation is on. It should be made clear in the tooltips or something which interest rate figures are real and which are nominal.

[David]

Now that I've got the needed details from the dev team, please see my replies below.

Played a game with insurance companies for the first time, and I have to say, it has been implemented quite nicely. I am using version 6.4.10.

Only things that have been issues are:

1. Even though the insurance company was very well equitized (>25% equity capital), the holding company stock price reacted in an extreme fashion to large negative net income. Come to think of it, it probably overreacted on the positive side as well when things recovered. Investors should probably look more at a normalized net income that assumes an average ROE over time based on a normalized ROI to determine appropriate P/B and keep P/B reasonably constant over time. Just taking raw unadjusted earnings and slapping a P/E on that results in crazy volatility, totally defeating the purpose of mark-to-market earnings.

Please download the latest post-release beta version 6.5.08.

It has improved the formula for determining the stock price of banks and insurance companies to reduce the stock fluctuation caused by irregular spikes or collapses of profits. The formula has incorporated the changes you suggested -- stock prices based on an average ROE over time based on a normalized ROI.

2. It is hard to track the performance of the insurance company's portfolio. The summary ROE metric is okay, but it would be good to be able to see total realized and unrealized gain on stocks and bonds + combined. Investment performance is a critical driver of success. Other useful metrics would be current average dividend yield on your equity portfolio and current average YTM on your bond portfolio.

In the latest version, you can now see a list of Financial Assets held by an insurance company by viewing the new “Financial Assets” report, under the “Financial” tab.

In the game, there is no distinction between realized and unrealized gain, insurance companies recognize changes in the fair value of equity investments through their income statement.
For more details, please see: viewtopic.php?f=52&t=7511&p=31379&hilit ... ain#p31387

3. When your insurance company runs out of cash but still has investment assets, the pop-up screen should let you choose to go to stock/bond market screen or fund transfer screen. It shouldn't be automatically just the fund transfer screen since you can just sell some assets to keep it cash positive so long as it has adequate reserves.

You can easily switch to the stock/bond market screen from the fund transfer screen using the shortcut key F4 or Ctrl-B as the game does not constrain the view to the fund transfer screen only.

4. An insurance company in my game collapsed leaving the HoldCo with deeply negative net assets on its balance sheet, but it seems like it isn't ever responsible for actually settling the claims (i.e., the company isn't bankrupt or losing cash, it is just sitting there). It seems like it should go bankrupt as the negative net assets would be like a bond coming due if the regulators forced a resolution or otherwise the claims would just need to be paid out over time somehow. There could be something more complex going on I don't understand.

When an insurance company is being closed down due to bankruptcy or forced by the parent company, it will liquidate all its financial assets, then return all claim reserves on the balance sheet to the policyholders. It already does so in the version you played.

5. There's a bug limiting the amount of bonds you can buy at once using your insurance company. It limits it to the amount of cash on the HoldCo balance sheet, which doesn't make sense. (You can also wind up buying too many bonds if HoldCo cash is greater than Insurance Co. cash).

This bug has been fixed. Please download the latest version.

6. Claims--I am still a bit confused about how these are presented. My understanding is you have a claims reserve for long tail policies like life insurance. I believe the reserve should change based more or less on the following formula:

Beginning Claims Reserve (This is a Credit Account on BS)
+ Reserve for New Policies (Credit Reserve, Debit Expense)
+ Accretion of Claims Reserve (Credit Reserve, Debit Expense)
+/- Change in Actuarial Assumptions (Credit/Debit Reserve, Credit/Debit Income/Expense)
- Claims Paid (Debit Reserve, Credit Cash)
Ending Claims Reserve

You reserve for new policies based on the present value of expected claims. You increase the reserves on existing policies by the discount rate over time (similar to the effect of amortization of a bond discount). Actuarial assumptions are updated on a regular basis to reflect changing expectations of future claims based on new evidence and changing discount rates (this could be simulated by randomly varying the assumed timing of future claims and varying the discount rate used to PV those yields according to the broader in-game interest rate). When claims come due, cash is paid out and the related reserve is extinguished (for life insurance... I suppose for other lines it might work a bit differently).

I think perhaps the current simulation deals with this well, but I want to know if the reserve accretes over time, which I think is important, and if claims vary randomly. With life insurance, the total dollar amount of future claims shouldn't vary, but I suppose the weighted average timing of them might. Changing interest rates have a huge impact on the liability side of insurance company balance sheets (higher interest rates decrease liabilities and lower interest decrease them). That's why they need to hold a portfolio of assets with a similar weighted average duration to their claims liabilities or otherwise hold a fair amount of excess capital.

Your assumption that the following are simulated in the game is correct.
Beginning Claims Reserve (This is a Credit Account on BS)
+ Reserve for New Policies (Credit Reserve, Debit Expense)
+ Accretion of Claims Reserve (Credit Reserve, Debit Expense)
- Claims Paid (Debit Reserve, Credit Cash)
Ending Claims Reserve

On the other hand, this one is not simulated in the game:
+/- Change in Actuarial Assumptions (Credit/Debit Reserve, Credit/Debit Income/Expense)

You wrote:
With life insurance, the total dollar amount of future claims shouldn't vary, but I suppose the weighted average timing of them might.
So I take that you meant that life insurance does not need to have changes in Actuarial Assumptions, right?

As you have mentioned, claims reserves are for long tail policies, so only life insurance has claim reserves. For Home and Car insurances, for the sake of maintaining gameplay simplicity, and also for the fact that they are not long tail policies, they actually do not have claims reserves.

7. What does the "Loan Interest Rate" mean at this point? Does it relate to bond yields and deposit/bank loan interest rates? Why are Treasury Yields presented as 2.75% when the Loan Interest Rate is 6.75%? I play with inverse inflation on, so it can be hard to understand what figures are nominal and which are real. I believe the yields are presented in real terms when inverse inflation is on. It should be made clear in the tooltips or something which interest rate figures are real and which are nominal.

The Loan Interest Rate you see on the panel below the minimap is a benchmark rate for bank loans.

Why are Treasury Yields presented as 2.75% when the Loan Interest Rate is 6.75%?

This is a good question. In the game, the Treasury Notes falls under the Global Bonds category. Mainly for gameplay balance, yields from investments from global bonds and stocks are not correlated to the local benchmark interest rate in the game. While one may argue that they should not be totally uncorrelated, but the downside risk of breaking the gameplay balance is not worth adhering to rigorous realism in this case.

[buells]

Thanks, David. The only actuarial assumption that might make sense to include is change in discount rate. The discount rate used to calculate the present value of the reserve liability is adjusted in-line with changes in the reinvestment rate for the weighted average maturity of the nominal reserve liabilities. If the discount rate goes down, the PV of the liability goes up and vise versa. If you have bonds or similar assets in the portfolio, they would tend to appreciate or depreciate similarly with respect to changes the risk free rate (or AA bond rate, at least that's what pensions use).

I guess I'm not too concerned about this, but the idea of having some kind of volatility in the amount of claims you have to pay out and the associated reserve, even if it is just random might make sense. Currently I feel it is a little too easy to just load up on stocks. Most insurance companies hold only a small fraction of their assets in equities, with most in bonds and a fair amount in loans.

Is there a reason Treasury rates can't be correlated to the loan base rate? They don't need to be the same, but could they follow the same pattern (e.g., consider y=mx+b where y=loan rate, b is a constant, x is the treasury rate, and m is the slope. M could be <1, implying the treasury rate changes in proportion to the loan rate but not as dramatically). I'm not too hung up on this either, but it is kind of strange to have discount rates that are totally uncorrelated.

[David]

Is there a reason Treasury rates can't be correlated to the loan base rate? They don't need to be the same, but could they follow the same pattern (e.g., consider y=mx+b where y=loan rate, b is a constant, x is the treasury rate, and m is the slope. M could be <1, implying the treasury rate changes in proportion to the loan rate but not as dramatically). I'm not too hung up on this either, but it is kind of strange to have discount rates that are totally uncorrelated.

I have got a clarification from the dev team that Treasury rates are in fact correlated to the loan base rate. When they added Treasury Notes to the game, they assigned the 'AAA' rating to Treasury Notes while capping all other types of bonds to the 'AA' rating at maximum, effectively creating a constant interest spread between Treasury Notes and any other types of bonds. As such, Treasury Notes always have lower yields than other bonds.

[buells]

Okay, that makes sense. It can be a little hard to tell as there isn't a Fed Funds Rate / LIBOR equivalent in the game (there's no need for one).