Risk Management for Insurers: Integration of Capital Management and Product Design

26 Pages Posted: 25 Aug 2016

See all articles by Hong Mao

Hong Mao

Shanghai Second Polytechnic University

James M. Carson

University of Georgia

Krzysztof Ostaszewski

Illinois State University

Nan Zhu

Pennsylvania State University - Smeal College of Business

Date Written: February 14, 2016

Abstract

In this paper, we extend Kliger and Levikson’s approach for pricing insurance contracts by considering the influence of capital held by an insurance firm on the price of insurance contracts, and we determine how to arrive at the optimal price, number of policies and capital level of the insurers. We also extend the above approach to a multi-line insurance firm. Our results are different from most of existing literature on capital allocation -- we show that even with multiple lines of business, the insurers still only need to hold a single overall capital allocation covering all of its lines of business, since the cost of capital and the probability of bankruptcy only depend on the total capital. Finally, our results also show that capital is an expensive resource, therefore, integrating capital management and optimization of price and product mix may be the most effective strategy of risk management especially when the capital cost is high.

Keywords: risk management, insurance pricing, cost of capital

JEL Classification: G22

Suggested Citation

Mao, Hong and Carson, James M. and Ostaszewski, Krzysztof and Zhu, Nan, Risk Management for Insurers: Integration of Capital Management and Product Design (February 14, 2016). Available at SSRN: https://ssrn.com/abstract=2824190 or http://dx.doi.org/10.2139/ssrn.2824190

Hong Mao

Shanghai Second Polytechnic University ( email )

No.2360, Jinhai Road
Shanghai, 201209
China

James M. Carson

University of Georgia ( email )

Athens, GA 30602-6254
United States

Krzysztof Ostaszewski (Contact Author)

Illinois State University ( email )

Department of Mathematics
Normal, IL 61790-4520
United States
+1-309-438-7226 (Phone)
+1-309-438-5866 (Fax)

HOME PAGE: http://math.illinoisstate.edu/krzysio

Nan Zhu

Pennsylvania State University - Smeal College of Business ( email )

University Park, PA 16802
United States

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