Early Warning Model for Solvency of Insurance Companies Using Machine Learning: Case Study of Iranian Insurance Companies

Subject Areas : Financial Mathematics

Saeed Naseri Khezerlou ¹ , Atousa Goodarzi ²

1 - Department of Insurance, ECO College of Insurance, Allameh Tabatabai University, Tehran, Iran
2 - Department of Insurance, ECO College of Insurance, Allameh Tabatabai University, Tehran, Iran

Received: 2023-04-25 Accepted : 2024-02-23 Published : 2024-04-27

Keywords: Insurance, Solvency, Early Warning Model, Machine Learning, Financial Ratio Analysis,

Abstract :

Stakeholders of an organization avoid undesirable outcomes caused by ignoring the risks. Various models and tools can be used to predict future outcomes, aiming to avoid the undesirable ones. Early warning models are one of the approaches that could help them in doing so. This study focuses on developing an early warning system using machine learning algorithms for predicting solvency in the insurance industry. This study analyses 23 financial ratios from Iranian general insurance companies listed on the Tehran Stock Exchange between 2015 and 2020. The model uses Decision Tree, Random Forest, Artificial Neural Networks, Gradient Boosting Machine and XGBoost algorithms, with Boruta as a feature selection method. The dependent variable is the solvency margin ratio, and the other 22 ratios are the independent variables, which Boruta reduces to 7 variables. Firstly, the performance of the machine learning models on two datasets, one with 22 independent variables and one with 7, is compared based on RMSE values. The XGBoost algorithm performs the best on both data sets. Additionally, the study predicts the 2020 values for 19 insurance companies, performs stage classifications, and compares actual stages to predicted stages. In this analysis, Random Forest has the best estimate accuracy on both data sets, while Gradient Boosting Machine has the best estimate accuracy on the Boruta data set. Finally, the study compares the machine learning models' results in terms of capital adequacy classification, where Random Forest performs the best on both data sets, and Gradient Boosting Machine on the Boruta data set.

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