Optimal Investment and Premium Policies under Risk Shifting and Solvency Regulation

Damir Filipovic, Robert Kremslehner and Alexander Muermann
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Damir Filipovic: Ecole Polytechnique Fédérale de Lausanne and Swiss Finance Institute
Robert Kremslehner: Vienna University of Economics and Business
Alexander Muermann: Vienna University of Economics and Business

No 11-11, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: Limited liability creates a conflict of interests between policyholders and shareholders of insurance companies. It provides shareholders with incentives to increase the risk of the insurer's assets and liabilities which, in turn, might reduce the value policyholders attach to and premiums they are willing to pay for insurance coverage. We characterize Pareto optimal investment and premium policies in this context and provide necessary and sufficient conditions for their existence and uniqueness. We then identify investment and premium policies under the risk shifting problem if shareholders cannot credibly commit to an investment strategy before policies are sold and premiums are paid. Last, we analyze the effect of solvency regulation, such as Solvency II or the Swiss Solvency Test, on the agency cost of the risk shifting problem and calibrate our model to a non-life insurer average portfolio.

Keywords: Risk Shifting; Insurance; Regulation; Pareto Optimality (search for similar items in EconPapers)
JEL-codes: D82 G11 G22 G28 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2011-03
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1111

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