A Fair Pool Sharing Mechanism for Illiquid Catastrophe Risk Markets

Munich Risk and Insurance Center Working Paper No. 19

25 Pages Posted: 9 May 2013 Last revised: 23 Mar 2015

See all articles by Gunther Kraut

Gunther Kraut

Ludwig-Maximilians-Universität Munich

Date Written: December 31, 2014

Abstract

For assuming risk in a multi-party risk pool of several insurance companies, a pool sharing mechanism, i.e., a type of pricing mechanism, is needed to determine each participant’s share of the pool’s losses. Based on axiomatic capital allocation principles, a fair and unique pool sharing mechanism is derived that differs from the current pooling solutions. Insights from game theory show that the mechanism is optimal in the sense of the Aumann-Shapley value. For this new application of these two theories, only small adaptations are necessary which are related to the differentiation between expected and unexpected losses. It is discussed why multi-party risk pools with this type of a pool sharing mechanism are particularly suitable for illiquid catastrophe risk markets. Special attention is given to the market for terrorism risk. A case study for portfolios of concentrated group life exposures shows that this type of a multi-party risk pool is feasible and economically beneficial.

Keywords: pool, risk pool, catastrophe risk, fair, pool sharing mechanism, pool share, illiquid

JEL Classification: C71, D21, G20, G22, G30, L10

Suggested Citation

Kraut, Gunther, A Fair Pool Sharing Mechanism for Illiquid Catastrophe Risk Markets (December 31, 2014). Munich Risk and Insurance Center Working Paper No. 19. Available at SSRN: https://ssrn.com/abstract=2262574 or http://dx.doi.org/10.2139/ssrn.2262574

Gunther Kraut (Contact Author)

Ludwig-Maximilians-Universität Munich ( email )

Schackstraße 4/III
München, 80539
Germany

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