Insurance Capital as a Shared Asset

Donald Mango

ASTIN Bulletin, 2005, vol. 35, issue 2, 471-486

Abstract: Merton and Perold (1993) offered a framework for determining risk capital in a financial firm based on the cost of the implicit guarantee the firm provides to its subsidiaries to make up any operating shortfall. Merton and Perold assume the price of such guarantees is observable from the market at large. For an insurer, this may not be a realistic assumption. This paper proposes an insurance-specific framework for determining the cost of those parental guarantees, and utilizing that cost in pricing and portfolio mix evaluation. An insurer’s capital is treated as a shared asset, with the insurance contracts in the portfolio having simultaneous rights to access potentially all that shared capital. By granting underwriting capacity, an insurer’s management team is implicitly issuing a set of options to draw upon the common capital pool — similar in structure to letters of credit (LOC), except they are not loans but grants. The paper will (i) discuss the valuation of parental guarantees, beginning with Merton and Perold; (ii) treat insurer capital as a shared asset and explore the dual nature of insurer capital usage; (iii) offer a method for determining insurer capital usage cost; and (iv) demonstrate how this method could be used for product pricing and portfolio mix evaluation using economic value added concepts.

Date: 2005
References: Add references at CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://www.cambridge.org/core/product/identifier/ ... type/journal_article link to article abstract page (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cup:astinb:v:35:y:2005:i:02:p:471-486_01

Access Statistics for this article

More articles in ASTIN Bulletin from Cambridge University Press Cambridge University Press, UPH, Shaftesbury Road, Cambridge CB2 8BS UK.
Bibliographic data for series maintained by Kirk Stebbing ().