Seminar by Daniel Bauer

Please Note: This seminar will be given in-person.

Dynamic Capital Allocation in General Insurance

Stochastic claims reserving models are used to generate projections for future cash flows in general insurance, and capital allocation models are used to allocate costly enterprise risk capital to business lines. However, despite their importance, these tasks are treated as independent steps with separate, inconsistent underlying models in insurance practice.

This paper resolves this inconsistency by integrating stochastic claims reserving and capital allocation models in their canonical form for a value-maximizing insurance company. We demonstrate that this integration yields different guidance for optimal portfolio choice relative to that obtained when separating the modeling steps. In particular, the integrated model attaches different valuation weights to cash flows with different tenors when determining risk-adjusted return ratios that characterize optimal exposures. Numerical results in a calibrated version of the model using common distributional assumptions showcase that these differences can be economically significant, and that the relative impact reverses depending on the capitalization of the firm. A long time until final resolution as within so-called long-tailed business lines can be advantageous or disadvantageous, depending on the company’s financial situation.