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Enhancing Market Performance with Profit-Based Contingent Commissions

This paper by Lan Ju and Mark J. Browne explores how profit-based contingent commissions can impact market cycles by incentivizing producers to steer business away from underpriced insurers. The study uses Loss Ratio Development and 2SLS testing to support the hypothesis. Strengths include the unique idea and comprehensive literature review. Suggestions for improvement include using the Heckman procedure, Hausman Test, and increasing the sample size.

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Enhancing Market Performance with Profit-Based Contingent Commissions

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  1. Contingent Commissions and Market Cycles Paper by: Lan Ju, UWI, Madison Mark J. Browne, UWI, Madison Discussed by: Puneet Prakash, VCU, Richmond

  2. 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

  3. 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.

  4. Strengths of the paper • Idea itself • Literature Review • Grace and Hotchkiss (1995)

  5. 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

  6. 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

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

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