Insurance Market Effects of Risk Management Metrics

Carole Bernard () and Weidong Tian ()
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Carole Bernard: Department of Statistics and Actuarial Science, University of Waterloo, Waterloo, ON N2L 3G1, Canada.
Weidong Tian: Department of Finance, University of North Carolina at Charlotte, NC 28223, USA.

The Geneva Risk and Insurance Review, 2010, vol. 35, issue 1, 47-80

Abstract: We extend the classical analysis on optimal insurance design to the case when the insurer implements regulatory requirements (Value-at-Risk). Presumably, regulators impose some risk management requirement such as VaR to reduce the insurers’ insolvency risk, as well as to improve the insurance market stability. We show that VaR requirements may better protect the insured and improve economic efficiency, but have stringent negative effects on the insurance market. Our analysis reveals that the insured are better protected in the event of greater loss irrespective of the optimal design from either the insured or the insurer perspective. However, in the presence of the VaR requirement on the insurer, the insurer's insolvency risk might be increased and there are moral hazard issues in the insurance market because the optimal contract is discontinuous.

Date: 2010
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