Quasi risk-neutral pricing in insurance

Niederau, Harry; Zweifel, Peter (2009). Quasi risk-neutral pricing in insurance. ASTIN Bulletin, 39(1):317-337.

Abstract

This contribution shows that for certain classes of insurance risks, pricing can be based on expected values under a probability measure P* amounting to quasi risk-neutral pricing. This probability measure is unique and optimal in the sense of minimizing the relative entropy with respect to the actuarial probability measure P, which is a common approach in the case of incomplete markets. After expounding the key elements of this theory, an application to a set of industrial property risks is developed, assuming that the severity of losses can be modeled by 'Swiss Re Exposure Curves', as discussed by Bernegger (1997). These curves belong to a parametric family of distribution functions commonly used by pricing actuaries. The quasi risk-neutral pricing approach not only yields risk exposure specific premiums but also Risk Adjusted Capital (RAC) values on the very same level of granularity. By way of contrast, the conventional determination of RAC is typically considered on a portfolio level only.

Abstract

This contribution shows that for certain classes of insurance risks, pricing can be based on expected values under a probability measure P* amounting to quasi risk-neutral pricing. This probability measure is unique and optimal in the sense of minimizing the relative entropy with respect to the actuarial probability measure P, which is a common approach in the case of incomplete markets. After expounding the key elements of this theory, an application to a set of industrial property risks is developed, assuming that the severity of losses can be modeled by 'Swiss Re Exposure Curves', as discussed by Bernegger (1997). These curves belong to a parametric family of distribution functions commonly used by pricing actuaries. The quasi risk-neutral pricing approach not only yields risk exposure specific premiums but also Risk Adjusted Capital (RAC) values on the very same level of granularity. By way of contrast, the conventional determination of RAC is typically considered on a portfolio level only.

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Item Type: Journal Article, refereed, original work 03 Faculty of Economics > Department of Economics 330 Economics English 2009 20 Jan 2010 13:03 05 Apr 2016 13:31 Peeters 0515-0361 https://doi.org/10.2143/AST.39.1.2038067

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