View Full Version : Balcarek's review of Ferrari
10-23-2005, 11:06 PM
In Balcarek's discussion of Ferrari's paper, he lists 3 powerful relationships. They are:
1. As P/S increases, I/A will tend to decrease
2. P/S moves in the same direction as U/P
3. I/A moves in the same direction as U/P
My question is how can all 3 be true? Is seems that if #2 and #3 are true then #1 can not also be true.
10-24-2005, 02:23 AM
I think he picks and chooses which effects he wants to discuss.
Recall that he assumes the risk to owners' equity remains unchanged. He basically says if something changes, the insurance company will do whatever it needs to do in order to keep a constant "risk to owners equity".
He isn't relying on mathematical relationships where you can take a derivative of this thing and look at how that must affect that thing.
Here's how I look at it:
1. Says (P/S) ^ => (I/A) v
The idea here is that the company is more highly leveraged, so mgmt gets conservative on their investments in order to maintain a constant level of risk to equity.
2. Says (U/P) ^ => (P/S) ^
If your underwriting improves, you can decide to write mor biz thus increasing your P/S.
3. Says that (I/A) goes in the SAME direction of (U/P).
Now we seem to have a contradiction. There are two ways out of the trap
(i) (U/P) ^, but we DECIDE not to grow - or maybe the market is saturated (number 2 above is not an issue now). We're profitable, so we can get a little more risky on our investments => (I/A) ^
(ii) (U/P) ^ and we decide to grow so (P/S) ^. One applies upward pressure on (I/A) while the other applies downward pressure. Maybe (I/A) moves just a tad up or down, or maybe it stays the same.
That's the way I think about it. Hoe it helps a little bit.
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