Capital allocation in insurance: Economic capital and the allocation of the default option value
Date
2004
Authors
Sherris, Michael
van der Hoek, John
Editors
Advisors
Journal Title
Journal ISSN
Volume Title
Type:
Conference paper
Citation
North American Actuarial Journal, 2006; 10 (2):39-61
Statement of Responsibility
Michael Sherris and John van der Hoek
Conference Name
International AFIR Colloquium 2004 (14th : 7 November 2004 : Boston, Massachusetts, USA)
Abstract
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, also
referred to as the insolvency exchange option, to lines of business. 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
multi-line insurer. We illustrate some other methods of capital allocation
and give numerical examples for the capital allocation of the default option
value based on explicit payoffs by line.
School/Discipline
School of Mathematical Sciences : Applied Mathematics