EconPapers    
Economics at your fingertips  
 

Pricing and Capital Allocation for Multiline Insurance Firms With Finite Assets in an Imperfect Market

John A. Major and Stephen J. Mildenhall

Papers from arXiv.org

Abstract: We analyze multiline pricing and capital allocation in equilibrium no-arbitrage markets. Existing theories often assume a perfect complete market, but when pricing is linear, there is no diversification benefit from risk pooling and therefore no role for insurance companies. Instead of a perfect market, we assume a non-additive distortion pricing functional and the principle of equal priority of payments in default. Under these assumptions, we derive a canonical allocation of premium and margin, with properties that merit the name the natural allocation. The natural allocation gives non-negative margins to all independent lines for default-free insurance but can exhibit negative margins for low-risk lines under limited liability. We introduce novel conditional expectation measures of relative risk within a portfolio and use them to derive simple, intuitively appealing expressions for risk margins and capital allocations. We give a unique capital allocation consistent with our law invariant pricing functional. Such allocations produce returns that vary by line, in contrast to many other approaches. Our model provides a bridge between the theoretical perspective that there should be no compensation for bearing diversifiable risk and the empirical observation that more risky lines fetch higher margins relative to subjective expected values.

Date: 2020-08
New Economics Papers: this item is included in nep-ias and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
http://arxiv.org/pdf/2008.12427 Latest version (application/pdf)

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:arx:papers:2008.12427

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().

 
Page updated 2020-10-03
Handle: RePEc:arx:papers:2008.12427