Risk-based capital for credit insurers with business cycles and dynamic leverage

Issouf Soumaré and Ernest Tafolong

Quantitative Finance, 2017, vol. 17, issue 4, 597-612

Abstract: This paper develops a risk-based capital pricing model for credit insurance portfolios held by a vulnerable insurer. The model accounts for business cycles using a two-state Markov switching model, and allows for dynamic leverage adjustment by the insured firms. The new proposed model, which incorporates risk-based capital practice, is better for both the insurer and the insured firms. Based on the risk-adjusted performance metric, we found that the insurer is better off insuring short- and medium-term loans in expansion and steady states, while it is better off backing both short- and long-term loans in recessions. Our results also emphasize that macroeconomic uncertainty significantly impairs the creditworthiness of the insurer and insured firms.

Date: 2017
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DOI: 10.1080/14697688.2016.1206960

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