Risk based capital and capital allocation in insurance (original) (raw)
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The determination and allocation of economic capital is important for pricing, risk management, and related insurer financial decision making. This paper considers the allocation of economic capital to lines of business in insurance. We show how to derive closed-form results for the complete markets, arbitrage-free allocation of the insurer default option value, or insolvency exchange option, to lines of business for an insurer balance sheet. We assume that individual lines of business and the surplus ratio are joint log-normal although the method we adopt allows other assumptions. The allocation of the default option value is required for fair pricing in the multiline insurer. We discuss and illustrate other methods of capital allocation, including Myers-Read, and give numerical examples for the capital allocation of the default option value based on explicit payoffs by line.
Solvency, Capital Allocation, and Fair Rate of Return in Insurance
Journal of Risk <html_ent glyph="@amp;" ascii="&"/> Insurance, 2006
In this paper we consider the links between solvency, capital allocation and fair rate of return in insurance. A method to allocate capital in insurance to lines of business is developed based on an economic definition of solvency and the market value of the insurer balance sheet. Solvency, and its financial impact, is determined by the value of the insolvency exchange option. The allocation of capital is determined using a comlete markets arbitrage-free model and, as a result, has desirable properties, such as the allocated capital "adds up" and is consistent with the economic value of the balance sheet assets and liabilities. A single period discrete state model example is used to illustrate the results. The impact of adding lines of business is briefly considered. The model is readily extended to a multi-period setting.
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This paper evaluates capital structure under risk-based capital regime from the perspective of insurance firms and its performance. It also evaluates the moderating effect of insurer’s risk profile on capital-performance relationship. The authors aim to reveal ambiguities, gaps and omissions in the literature and to sketch avenues for future research. A conceptual framework for capital structure under risk-based capital era and its application is suggested focusing on equity, technical provision and required risk propensity for maximizing profit and wealth for all stakeholders. The research reviews that capital structure of insurers differs from non-insurance firms as such risk-based capital regulation must not only focus on the various types of risk but also recognized these differences. It is shown that insurers’ capital structure contains equity and technical provisions which comprises creditors and accruals, outstanding claims and insurance funds instead of equity and financial ...
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