21.4 Reinsurance and Market Value

Measure the impact on the value of the firm instead of the impact on capital

• Given 2 actions, the one that increases the value the most on a risk-adjusted basis would be preferred

• Caveat: We don’t know how this can be done

• Currently: we measure value of the stability that reinsurance provides by measuring the reduction in capital

• Next step: Measure the value of reinsurance by measuring the \(\Delta\) in the value of the company

Highlights from recent studies

• Insureds demand price discounts of 10-20 times the expected cost of an insurer default (EPD)

  • e.g. 0.5% default, expected cost = 100K if default

    \(\Rightarrow\) EPD = 500

    \(\Rightarrow\) Discount demand = 500 \(\times\) 10 or 20 = 5-10K

• 1% decrease in capital \(\Rightarrow\) 1% loss in pricing level

• 1% increase in \(\sigma_{earnings}\) \(\Rightarrow\) 0.33% decrease in pricing level

• Rating upgrades is worth 3% of business growth

• Rating downgrades can drop business by 5-20%