Risk Management and Capital Allocation for Non-Life Insurance Companies

Abstract

This paper deals with some key issues related to risk and capital allocation in non life insurance. There is an increasing concern about quantifying the capital requirements for financial entities. Actually, the major part of the insurance regulation aims to provide a clear guideline for insurers to manage with this issue. For example, the new European insurance regulatory system Solvency II focuses in this direction. In this risk based capital system, the required capital is based on two building blocks: the minimum capital requirement and the solvency capital requirement very close to the theoretical concept of economic capital. How much capital should an insurance firm hold? And what rate of return must the firm achieve on this capital? How should the required capital be allocated to different lines of business and products sold? While these questions are of critical importance to the firm, external forces in the operating environment often dictate the answers. For example, regulators and rating agencies greatly influence the amount of capital the firm must hold; in addition, investors influence both the amount of capital the firm holds and the required rate of return on this capital. Therefore, the issues of the amount of capital and the required rate of return on capital are often ultimate beyond the decision-making power of the company; rather, they are demands that the operating environment imposes upon the firm.