Lecture 4

GameStop, WSB, and Short Squeeze

Surprise Billing
Risk Forecasting and Measurement
 CPCU
• The American Institute for Chartered Property
Casualty Underwriters (AICPCU) and the
Insurance Institute of America (IIA) are
independent, nonprofit organizations offering
educational programs and professional
certification to people in all segments of the
property and liability insurance business.
– CPCU is the industry's most respected
professional designation
 CPCU

• You must pass a minimum of eight courses (five foundation

courses, plus three from either concentration) to earn the
CPCU designation. (See www.aicpcu.org for updated info).
• Four core courses:
• CPCU 510 Foundations of Risk Management, Insurance, and
Professionalism
• CPCU 520 Insurance Operations and Regulation
• CPCU 530 The Legal Environment of Risk Management and
Insurance
• CPCU 540 Business and Financial Analysis for Risk
Management and Insurance Professionals
 CPCU
• Three courses in either the personal or commercial
concentration
• Commercial Concentration
• CPCU 551 Commercial Property Risk Management and
Insurance
• CPCU 552 Commercial Liability Risk Management and
Insurance
• CPCU 553 Survey of Personal Risk Management, Insurance,
and Financial Planning
• Personal Concentration
• CPCU 555 Personal Risk Management and Property-Liability
Insurance
• CPCU 556 Personal Financial Planning
• CPCU 557 Survey of Commercial Risk Management and
Insurance
 CPCU
• One of the Elective Courses
AAI 83 Agency Operations and Sales Management
AIC 34 Workers Compensation and Managing Bodily Injury Claims
AIC 35 Property Loss Adjusting
AIC 36 Liability Claim Practices
ARe 144 Reinsurance Principles and Practices
ARM 56 Risk Financing
AU 65 Commercial Underwriting: Principles and Property
AU 66 Commercial Underwriting: Liability and Advanced Techniques
CPCU 560 Financial Services Institutions
ERM 57 Enterprise-Wide Risk Management: Developing and Implementing
Shorting
 Shorting
• But when you short a stock and it rises,
there is no limit to how high it can go.
When traders make short sales, their
brokers demand a margin payment, which is
taken from their accounts to offset potential
losses. As the stock's price rises, the short
seller's losses grow, and the broker requires
ever more margin payments.
 Short Squeeze
• In the case of a short squeeze, short sellers
are forced to panic-buy a stock so they can
return it to their lenders before margin calls
make them go broke. The buying pressure
forces the stock price up even farther,
leading to even more panic-buying from
short sellers trying to cover their trades.
Surprise Medical Bills (Surprise/Balance Billing)
 States with States with
Comprehensive Limited
Protection Protection
• California • Arizona
• Colorado • Delaware
• Connecticut • Indiana
• Florida • Iowa
• Illinois • Maine
• Maryland • Massachusetts
• New Hampshire • Minnesota
• New Mexico • Mississippi
• New York • Missouri
• Oregon • North Carolina
• Texas • Pennsylvania
• Virginia • Rhode Island
• Washington • Vermont
 Federal Surprise Billing Legislation Proposals

• State laws cannot fully protect consumers. They can’t help people covered by
their employer’s self-funded plans, since federal ERISA law bars states from
regulating them. States are also restricted from protecting people who receive
surprise bills because of air ambulance services.
• In early February (2020), two federal bills targeting surprise billing in
healthcare advanced out of committee.  On February 11, the House Education
and Labor Committee passed the Ban Surprise Billing Act (H.R. 5800), which
was introduced by Chairman Rep. Bobby Scott (D. – Virginia) and Ranking
Member Rep. Virginia Foxx (R. – North Carolina).  One day later, the House
Ways and Means Committee unanimously advanced the Consumer Protections
Against Surprise Medical Bills Act (H.R. 5826), led by Chairman Rep.
Richard Neal (D. – Massachusetts) and Ranking Member Rep. Kevin Brady
(R. – Texas).  Both bills would prohibit providers from balance billing patients
for surprise medical bills and would limit patients’ cost-sharing to in-network
amounts.
Federal Spending Bill (12/21/2020)
• Still, the bill does not extend its consumer protections to the far more
commonly used ground ambulance services.
• In some cases, physicians can balance-bill their patients, but they must get
consent in advance.
– This part of the bill is aimed at patients who want to see an out-of-
network physician, perhaps a surgeon or obstetrician recommended by a
friend.
 Risk Management
• Risk management process
– Step 1: Identifying loss exposures
– Step 2: Analyzing loss exposures
• Loss forecasting
– Step 3: Examining the feasibility of risk management
techniques
– Step 4: Selecting the appropriate risk management
techniques
– Step 5: Implementing the selected risk management
techniques
– Step 6: Monitoring results and revising the risk
management program
 Analyze Loss Exposures
• Loss forecasting
– Loss severity
• probable size of the loss that may occur
– Loss frequency
• probable number of the loss that may occur
 Loss Forecasting
• Loss forecasting techniques
– Probability analysis
• A technique for forecasting losses, on the
assumption that they are governed by an unchanging
probability distribution
– Probability distribution
» A presentation of the probability of each possible
outcome of an event
– Trend analysis
 Probability Distributions - Example
Number of Hurricanes Making Landfall in Florida during One Hurricane
Season
Number of Hurricanes Making Probability
Landfall
0 .300
1 .350
2 .200
3 .147
4 .002
5+ .001
 Probability Distributions
• Probability distributions
– Empirical probabilities
• Deduced from historical data
– Ex., number of hurricanes in Florida
– Theoretical probabilities
• Based on theoretical principles rather than on actual
experience
– Ex., number of heads in tossing a coin
» Probability (1 head in tossing a coin 3 times) = ?
Probability Distributions – Example

How many hurricanes do you expect for the next

hurricane season?
Number of Hurricanes Making Probability
Landfall
0 .300
1 .350
2 .200
3 .147
4 .002
5+ .001
 Probability Distributions
• Expected value
– The weighted average of all the possible
outcomes of a probability distribution
• The weights are the probabilities of the outcomes
 Probability Distributions
• Example – probability
distributions:

Number of Losses X x1 x2 x3 … xn
Probability p1 p2 p3 … pn
 Expected Value
• To find the mean of X, multiply each
possible value by its probability, then add
all the products:
 x  x1 p1  x 2 p 2  ...  x k p k
k
  xi pi
i 1
How many hurricanes do you expect for the next
hurricane season?

Expected value = ??
Number of Hurricanes Making Probability
Landfall
0 .300
1 .350
2 .200
3 .147
4 .002
5+ .001
 Probability Distributions
• Probability distributions
– Discrete probability distributions
• A table listing the probability of every possible outcome
– The outcomes are countable
– Discrete probability distributions are typically used as frequency
distributions – that is, to analyze how often something will occur
– Continuous probability distributions
• Typically used for severity distributions
– The loss can take any value between 0 and some upper limit
 Probability Distributions
- For a discrete random variable, the probability
distribution is defined by a probability
function, denoted by p(x)
- For a continuous random variable, the
probability distribution is defined by a
probability density function, f(x)
 Probability Function
• A probability function gives the probability
p(x) when the random variable equals x, for
each value x
– Relationship between each value x and its
probability

p( x)  P( X  x)
 Probability Function
• Example:
• Probability function of number of heads (X) in
tossing a coin four times:

X 0 1 2 3 4
P(X) 1/16 1/4 3/8 1/4 1/16
 Continuous Random Variables
• A continuous random variable has a
continuum of possible values
– Such as all values between 0 and 100 or all
values greater than 0
 Probability Density Function
• Example: normal probability density
function
1  ( x   ) 2 / 2 2
f ( x)  e ,
 2
   x  
 Continuous Probabilities
• Continuous probabilities
– Probabilities for intervals:
• Area under the graph of f(x) corresponding to a
given interval
– The probability that the continuous random variable x
assumes a value in that interval
 Computing Probabilities
• Example:
– p(c<x<d): the area under the graph of f(x)
corresponding to the interval c<x<d
 Finding Probabilities
Probability is
the area under
the curve! P c  X  d   ?

f(X)

X
c d
Normal Probability Distributions
• The most important continuous probability
distribution is
– Normal probability distribution
Normal Probability Distributions
• We use the notation N (  ,  ) to refer
to the normal probability distribution with
mean  and standard deviation  .
– For example, N (2,1) refers to the normal
distribution with mean -2 and standard
deviation 1.
 Normal Distributions
There are an Infinite Number of Normal Distributions

Varying the Parameters  and , We Obtain

Different Normal Distributions
 Standard Normal Distributions
• A normal distribution with   0 and
  1 is called a standard normal
distribution
 Standard Normal Probabilities

Z  0 Z 1
Z .00 .01 .02
.5478
0.0 .5000 .5040 .5080

0.1 .5398 .5438 .5478

0.2 .5793 .5832 .5871 0
Probability
0.3 .6179 .6217 .6255 Z = 0.12
 Standardization
• Transformation formula: the Z value is
equal to the difference between X and the
population mean  , divided by the
standard deviation  .

X 
Z

 Normal Probabilities - Example
X   51.2  50
Z   0.12
 10
Normal Distribution Standard
Normal Distribution
  10 Z 1

51.2 X 0.12 Z
  50 Z  0
 Normal Probabilities
• We can use Excel to compute normal
probabilities for any normal distributions:

NORMSDIST ( z )  p ( Z  z )
NORMDIST ( x,  ,  , TRUE )  p( X  x)
 Loss Forecasting
• Loss forecasting techniques
– Probability analysis
• A technique for forecasting losses, on the
assumption that they are governed by an
unchanging probability distribution
– Trend analysis
• Identifies patterns in past losses and then projects
these patterns into the future
– Trend analysis allows for a dynamic, changing
environment
 Trend Analysis
• Trend analysis
– Time trends
• Track accidental loss through time by looking for a
linear time trend line
– Regression analysis
 Time Trends
Year 1 2 3 4

Actual Losses 4 4 5 6

Diagram of a Time Trend Line

9
8 y = 0.7x + 3
Annual Number of Losses

7
6
5
4
3
2
1
0
0 2 4 6 8
Year
 Trend Analysis
• Trend analysis
– Time trends
– Regression analysis
• Estimates relationship between variables
– Assumes that the variable (loss) being forecast varies
predictably with some other variable
 Regression Analysis - Example
Relationship of Losses to Output

YEAR Annual Number of Tons of Output (

Losses x 100,000)
1 4 35

2 4 60

3 5 72

4 6 95
Regression Analysis – Diagram of
Linear Regression Line
Diagram of Linear Regression Line

8
Annual Number of Losses

7 y = 0.035x + 2.4594
6
5
4
3
2
1
0
0 50 100 150
Tons of Output (x100,000)