Is the insurance industry ready?
“Ruin Theory” may not have the most charming name, as far as most fields of study go, but it very much forms a key digit on the invisible hand which guides our economy. “Ruin Theory is the mathematical study of how likely an insurance firm is to run out of money,” explains Kristina Sendova of the Department of Statistical and Actuarial Sciences. “There are mass-scale events, like natural disasters or even the current financial downturn due to the Covid-19 pandemic, which would cause millions of claims to simultaneously be submitted by individuals to an insurer,” she says. If the insurer does not have enough cash on hand to pay out the incoming claims, individuals, families, and businesses can be left emptyhanded.
This theoretical field uses statistics to model the profitability and the associated risks of an insurance company, such as its cashflow and risk. “Regardless of whether it is insurance for our homes, cars, businesses, or even lives, we expect a stable industry,” says Sendova. The insurance payouts, upon which the lives of millions are dependent, require savvy fiscal management on the part of the insurance firm to ensure that they are there when we need them most. Therefore, investment risks and product pricing of an insurance firm are tightly regulated to safeguard the capacity of the industry to preserve the financial stability of individuals as well as private and public sector clients during times of economic instability.
These regulations, built upon the mathematical models of Ruin Theory, have very tangible consequences in daily life. “Our research accounts for seasonal fluctuations in insurance dynamics, like increased car accidents in winter, with rare, massive events like the Great Recession that culminated in 2008,” explains Sendova. “The result of this number-crunching by our group is a set of recommendations to insurance companies on how to most effectively manage their funds”. “After all, their investment returns are what allow the companies to keep their premiums low, so even though our work is geared towards the industry, it is ultimately individuals who require sound risk management to preserve their insured assets,” she tells.
The global-scale financial upheaval resulting from the Covid-19 pandemic is, from a statistical standpoint, a type of event that seems to occur about once a century. In this type of situation, an insurance company’s financial portfolio will suffer great losses. Compounding this financial strain, the company also faces a spike in payouts to their customers, many of whom have faced illness, disability, unemployment or whose businesses have suffered. This can significantly jeopardize the insurer’s ability to meet its obligations to its clientele. Sendova and her group work with large insurance companies to design financial plans based on the researchers’ predictive analytics to keep the organizations afloat in times of financial turmoil.