Enhanced Pricing and Management of Bundled Insurance Risks with Dependence-aware Prediction using Pair Copula Construction

TL;DR

This paper introduces a dependence-aware predictive modeling framework for multivariate insurance risks with bundling features, capturing complex dependencies to improve pricing and risk management decisions.

Contribution

The paper develops a novel pair copula construction-based model that fully captures dependence among multivariate longitudinal risks, enhancing insurance risk assessment.

Findings

Improved insurance pricing with a 9% revenue lift.

Underestimation of risk by 10% when ignoring dependence.

Model performs well in simulation and real data applications.

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. The proposed model 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.