Risk Management for Insurers: Integration of Capital Management and Product Design
26 Pages Posted: 25 Aug 2016
Date Written: February 14, 2016
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
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