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Ambiguity and Insurance: Capital Requirements and Premiums

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  • Simon Dietz
  • Oliver Walker

Abstract

Many insurance contracts are contingent on events such as hurricanes, terrorist attacks, or political upheavals, whose probabilities are ambiguous. This article offers a theory to underpin the large body of empirical evidence showing that higher premiums are charged under ambiguity. We model a (re)insurer that maximizes profit subject to a survival constraint that is sensitive to the range of estimates of the probability of ruin, as well as the insurer's attitude toward this ambiguity. We characterize when one book of insurance is more ambiguous than another and general circumstances in which a more ambiguous book requires at least as large a capital holding. We subsequently derive several explicit formulae for the price of insurance contracts under ambiguity, each of which identifies the extra ambiguity load.

Suggested Citation

  • Simon Dietz & Oliver Walker, 2019. "Ambiguity and Insurance: Capital Requirements and Premiums," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 86(1), pages 213-235, March.
    • Handle: RePEc:bla:jrinsu:v:86:y:2019:i:1:p:213-235
    DOI: 10.1111/jori.12208
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    Cited by:

    1. Chia‐Chun Chiang & Hugh Hoikwang Kim & Greg Niehaus, 2022. "Opaque liabilities, learning, and the cost of equity capital for insurers," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 89(4), pages 1031-1076, December.
    2. Simon Dietz & Falk Niehörster, 2021. "Pricing ambiguity in catastrophe risk insurance," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 46(2), pages 112-132, September.
    3. Johanna Etner & Meglena Jeleva & Natacha Raffin, 2021. "Climate policy: How to deal with ambiguity?," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 72(1), pages 263-301, July.
    4. Maristella Botticini & Pietro Buri & Massimo Marinacci, 2023. "Presidential Address 2023: The Beauty of Uncertainty: The Rise of Insurance Contracts and Markets in Medieval Europe," Journal of the European Economic Association, European Economic Association, vol. 21(6), pages 2287-2326.

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