Modeling financial reinsurance in the casualty insurance business via stochastic programming
✍ Scribed by Petter E. de Lange; Stein-Erik Fleten; Alexei A. Gaivoronski
- Publisher
- Elsevier Science
- Year
- 2004
- Tongue
- English
- Weight
- 352 KB
- Volume
- 28
- Category
- Article
- ISSN
- 0165-1889
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✦ Synopsis
In this paper, we examine the rationale for ÿnancial reinsurance in the casualty insurance business. As opposed to regular reinsurance, ÿnancial reinsurance refers to an investment strategy that uses the ÿnancial markets to hedge insurance risk. The casualty insurer takes positions in derivatives on underlying assets whose prices are highly positively or negatively correlated with speciÿc insurance risks. We formulate the asset liability management problem for a mutually owned casualty insurer, in the context of a dynamic stochastic portfolio selection model. Using numerical studies of the resulting large-scale non-linear program, we compare properties of optimal portfolios with and without the possibility of ÿnancial reinsurance. We let an alleged representative policyholder, endowed with a linear plus negative exponential utility function, evaluate the various optimal portfolios. When policyholders' utility functions exhibit reasonable levels of risk aversion, we ÿnd that portfolios re ecting ÿnancial reinsurance dominate portfolios that are not ÿnancially reinsured.