Non-Markov Effects and Property-Liability Insurer Rating Transitions
25 Pages Posted: 20 Dec 2009 Last revised: 14 Oct 2010
Date Written: September 29, 2010
We extend the results of Lando and Skødeberg (2002) with the first examination of non-Markov effects for property-liability insurer rating transitions. Results provide evidence for the existence of three rating phenomena, including an initial rating effect (future rating transitions depend on the insurer’s existing rating), momentum drift (future downgrades and upgrades are associated with the insurer’s past downgrades and upgrades), and time dependence (the longer an insurer’s rating remains in a given category, the lower the likelihood that the rating will change). Based on the Cox proportional hazard model and A.M. Best ratings for the period 1995 to 2006, findings indicate the presence of significant non-Markov effects, generally for both insurer rating upgrades and downgrades, which is different from the results in the financial sector indicated by Lando and Skødeberg (2002).
Keywords: Non-Markovian Behaviors, Rating Drift, Insurer Solvency, Cox Model
JEL Classification: C14, C34, C41, G24
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