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Combining fair pricing and capital requirements for non-life insurance companies

  • Gatzert, Nadine
  • Schmeiser, Hato
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    The aim of this article is to identify fair equity-premium combinations for non-life insurers that satisfy solvency capital requirements imposed by regulatory authorities. In particular, we compare target capital derived using the value at risk concept as planned for Solvency II in the European Union with the tail value at risk concept as required by the Swiss Solvency Test. The model framework uses Merton's jump-diffusion process for the market value of liabilities and a geometric Brownian motion for the asset process; fair valuation is conducted using option pricing theory. We show that even if regulatory requirements are satisfied under different risk measures and parameterizations, the associated costs of insolvency - measured with the insurer's default put option value - can differ substantially.

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    File URL: http://www.sciencedirect.com/science/article/B6VCY-4SMWFDG-2/2/8db2190fb56b8b34d13cadabc2453ec1
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    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 32 (2008)
    Issue (Month): 12 (December)
    Pages: 2589-2596

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    Handle: RePEc:eee:jbfina:v:32:y:2008:i:12:p:2589-2596
    Contact details of provider: Web page: http://www.elsevier.com/locate/jbf

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    1. Merton, Robert C., 1976. "Option pricing when underlying stock returns are discontinuous," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 125-144.
    2. Gatzert, Nadine & Schmeiser, Hato, 2008. "The influence of corporate taxes on pricing and capital structure in property-liability insurance," Insurance: Mathematics and Economics, Elsevier, vol. 42(1), pages 50-58, February.
    3. Philippe Artzner & Freddy Delbaen & Jean-Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228.
    4. David Cummins, J. & Sommer, David W., 1996. "Capital and risk in property-liability insurance markets," Journal of Banking & Finance, Elsevier, vol. 20(6), pages 1069-1092, July.
    5. Thomas Møller, 2004. "Stochastic orders in dynamic reinsurance markets," Finance and Stochastics, Springer, vol. 8(4), pages 479-499, November.
    6. Michael Sherris, 2006. "Solvency, Capital Allocation, and Fair Rate of Return in Insurance," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 73(1), pages 71-96.
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