Optimal pooling strategies under heterogeneous risk classes
ISSN: 1526-5943
Article publication date: 3 July 2020
Issue publication date: 28 August 2020
Abstract
Purpose
The purpose of this paper is to determine optimal pooling strategies from the perspective of an insurer's shareholders underlying a default probability driven premium loading and convex price-demand functions.
Design/methodology/approach
The authors use an option pricing framework for normally distributed claims to analyze the net present value for different pooling strategies and contrast multiple risk pools structured as a single legal entity with the case of multiple legal entities. To achieve the net present value maximizing default probability, the insurer adjusts the underlying equity capital.
Findings
The authors show with the theoretical considerations and numerical examples that multiple risk pools with multiple legal entities are optimal if the equity capital must be decreased. An equity capital increase implies that multiple risk pools in a single legal entity are generally optimal. Moreover, a single risk pool for multiple risk classes improves in relation to multiple risk pools with multiple legal entities whenever the standard deviation of the underlying claims increases.
Originality/value
The authors extend previous research on risk pooling by introducing a default probability driven premium loading and a relation between the premium level and demand through a convex price-demand function.
Keywords
Acknowledgements
The authors would like to thank Martin Eling, Michael R. Powers, Andre Veiga, the anonymous referees, the participants of the DVfVW Annual Meeting 2018 in Munich, Germany, the participants of the joint Conference of the IRFRC-APRIA 2018 in Singapore, and the participants of the 45th Seminar of the EGRIE 2018 in Nuremberg, Germany, for their valuable advice.
Citation
Klein, F. and Schmeiser, H. (2020), "Optimal pooling strategies under heterogeneous risk classes", Journal of Risk Finance, Vol. 21 No. 3, pp. 271-298. https://doi.org/10.1108/JRF-11-2019-0222
Publisher
:Emerald Publishing Limited
Copyright © 2020, Emerald Publishing Limited