Pragmatic insurance option pricing

Jon Holtan

Scandinavian Actuarial Journal, 2007, vol. 2007, issue 1, 53-70

Abstract: This paper deals with theoretical and practical pricing of non-life insurance contracts within a financial option pricing context. The market-based assumption approach of the option context fits well into the practical nature of non-life insurance pricing and valuation. The fundamental characteristics of most insurance markets, such as the apparent variation in insurer price offers for the same risk in the same market, support the need for a market based approach. The paper outlines insurance and option pricing in a parallel setup. First it takes a complete market approach, focusing on dynamic hedging, no-arbitrage and risk-neutral martingale valuation principles within insurance and options. Secondly it takes an incomplete market view by introducing supply and demand effects via purchasing preferences in the market. Finally the paper discusses market-based insurance price models, parameter estimation techniques and international best practice of insurance pricing. The general purpose of the paper is to describe and unite the headlines of the more or less common insurance and option pricing theory, and hence increase the pragmatic understanding of this theory from a business point of view.

Date: 2007
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DOI: 10.1080/03461230601088213

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