Risk Measures and Economic Capital for (Re)Insurers

Abstract

AbstractThis contribution relates to the use of risk measures for determining (re)insurers' economic capital requirements. Alternative sets of properties of risk measures are discussed. Furthermore, methods for constructing risk measuresviaindifference arguments, representation results, and reweighting of probability distributions are presented. How these different approaches relate to popular risk measures, such as value‐at‐risk, expected shortfall, distortion risk measures, and the exponential premium principle, is also dealt with. The problem of allocating aggregate economic capital to subportfolios (e.g., insurers' lines of business) is then considered, with particular emphasis on marginal‐cost‐type methods. The relationship between insurance pricing and capital allocation is briefly discussed, based on concepts such as the opunity and frictional costs of capital and the impact of the potential of default on insurance rates.