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
Date Written: December 31, 2014
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: Suggested Citation