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Optimal insurance purchase strategies via optimal multiple stopping times

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  • Rodrigo S. Targino
  • Gareth W. Peters
  • Georgy Sofronov
  • Pavel V. Shevchenko
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    Abstract

    In this paper we study a class of insurance products where the policy holder has the option to insure $k$ of its annual Operational Risk losses in a horizon of $T$ years. This involves a choice of $k$ out of $T$ years in which to apply the insurance policy coverage by making claims against losses in the given year. The insurance product structure presented can accommodate any kind of annual mitigation, but we present three basic generic insurance policy structures that can be combined to create more complex types of coverage. Following the Loss Distributional Approach (LDA) with Poisson distributed annual loss frequencies and Inverse-Gaussian loss severities we are able to characterize in closed form analytical expressions for the multiple optimal decision strategy that minimizes the expected Operational Risk loss over the next $T$ years. For the cases where the combination of insurance policies and LDA model does not lead to closed form expressions for the multiple optimal decision rules, we also develop a principled class of closed form approximations to the optimal decision rule. These approximations are developed based on a class of orthogonal Askey polynomial series basis expansion representations of the annual loss compound process distribution and functions of this annual loss.

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    File URL: http://arxiv.org/pdf/1312.0424
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1312.0424.

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    Date of creation: Dec 2013
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    Handle: RePEc:arx:papers:1312.0424

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    1. Jondeau, Eric & Rockinger, Michael, 2001. "Gram-Charlier densities," Journal of Economic Dynamics and Control, Elsevier, vol. 25(10), pages 1457-1483, October.
    2. René Carmona & Nizar Touzi, 2008. "Optimal Multiple Stopping And Valuation Of Swing Options," Mathematical Finance, Wiley Blackwell, Wiley Blackwell, vol. 18(2), pages 239-268.
    3. Ghossoub, Mario, 2010. "Supplement to "Belief heterogeneity in the Arrow-Borch-Raviv insurance model"," MPRA Paper 37717, University Library of Munich, Germany, revised 22 Mar 2012.
    4. Patrick Jaillet & Ehud I. Ronn & Stathis Tompaidis, 2004. "Valuation of Commodity-Based Swing Options," Management Science, INFORMS, INFORMS, vol. 50(7), pages 909-921, July.
    5. Ghossoub, Mario, 2010. "Belief heterogeneity in the Arrow-Borch-Raviv insurance model," MPRA Paper 37630, University Library of Munich, Germany, revised 22 Mar 2012.
    6. Christian Gollier, 2005. "Some Aspects of the Economics of Catastrophe Risk Insurance," CESifo Working Paper Series 1409, CESifo Group Munich.
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