Hedging the Tax Liability of a Property-Liability Insurance Company

The income tax burden placed upon a property-liability insurance company creates a variable liability with profound effects on the functioning of the enterprise. It directly affects product pricing and asset investment policies and, therefore, the potential profitability of the insurer. Recent research works have identified fuzzy sets theory as a potentially useful modeling paradigm for insurance uncertainty—in claim cost forecasting, underwriting, rate classification, and premium determination. We view the insurance liabilities, properly priced, as a hedge against the short position in the government tax option. Uncertainty in the critical parameters of underwriting and investment are modeled as fuzzy numbers, leading to a mixed model of uncertainty in the tax rate, rate of return and the liability hedge. This paper was presented at the Financial Institutions Center's May 1996 conference on "