Measurement and Pricing of Risk in Insurance Markets

16 Pages Posted: 7 Nov 2006

See all articles by Andreas Tsanakas

Andreas Tsanakas

Mayer, Brown, Rowe & Maw LLP - London - Lloyds Office

Evangelia Desli

Aristotle University of Thessaloniki - School of Economics

Abstract

The theory and practice of risk measurement provides a point of intersection between risk management, economic theories of choice under risk, financial economics, and actuarial pricing theory. This article provides a review of these interrelationships, from the perspective of an insurance company seeking to price the risks that it underwrites. We examine three distinct approaches to insurance risk pricing, all being contingent on the concept of risk measures. Risk measures can be interpreted as representations of risk orderings, as well as absolute (monetary) quantifiers of risk. The first approach can be called an "axiomatic" one, whereby the price for risks is calculated according to a functional determined by a set of desirable properties. The price of a risk is directly interpreted as a risk measure and may be induced by an economic theory of price under risk. The second approach consists in contextualizing the considerations of the risk bearer by embedding them in the market where risks are traded. Prices are calculated by equilibrium arguments, where each economic agent's optimization problem follows from the minimization of a risk measure. Finally, in the third approach, weaknesses of the equilibrium approach are addressed by invoking alternative valuation techniques, the leading paradigm among which is arbitrage pricing. Such models move the focus from individual decisiontakers to abstract market price systems and are thus more parsimonious in the amount of information that they require. In this context, risk measures, instead of characterizing individual agents, are used for determining the set of price systems that would be viable in a market.

Suggested Citation

Tsanakas, Andreas and Desli, Evangelia, Measurement and Pricing of Risk in Insurance Markets. Risk Analysis, Vol. 25, No. 6, pp. 1653-1668, December 2005. Available at SSRN: https://ssrn.com/abstract=943169 or http://dx.doi.org/10.1111/j.1539-6924.2005.00684.x

Andreas Tsanakas (Contact Author)

Mayer, Brown, Rowe & Maw LLP - London - Lloyds Office ( email )

One Lime Street
Suite 874
London, EC3M 7DQ
United Kingdom
+44 0 20 73275268 (Phone)
+44 0 20 73275658 (Fax)

Evangelia Desli

Aristotle University of Thessaloniki - School of Economics ( email )

Thessaloniki, 54124
Greece

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