Capital Consumption: An Alternative Methodology for Pricing Reinsurance

This paper introduces a capital consumption methodology for the price evaluation of reinsurance in a stochastic environment.

It differs from the common practice of risk-based capital allocation and release by:

(i) evaluating the actual contract cash flows at the scenario level;

(ii) eliminating the need for contract-level supporting capital allocation and release;

(iii) evaluating each scenario’s operating deficits as contingent capital calls on the company capital pool; and

(iv) reflecting the expected cost of contingent capital calls as an expense load.

This method eliminates the need for capital allocation and release; creates scenarios that more closely model actual contract capital usage; allows more flexibility in stochastic modeling; and makes risk-return preferences an explicit part of the pricing decision.

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Courtesy: Donald Mango, American Re-Insurance, Munich Re,2003 ASTIN Colloquium. www.actuaries.org