Insurance Capital as a Shared Asset [Discussion]

In his 2005 ASTIN paper (reprinted in the CAS 2006 Fall Forum), Donald Mango's ground-breaking work [1] in developing the concepts of insurance capital as a shared asset and Economic Value Added (EVA) are discussed with special emphasis on the purpose and calculation of the important Capital Call Costs. The EVA approach permits one to charge for risk (capital usage) and measure profitability at any desired level of definition while satisfying the key additivity property for risk charges without needing to allocate capital. Test examples are discussed that illustrate the impact on profitabilty of rate changes, changes in the distributions of premium written by line of business, inaccurate pricing due to parameter and model risk, correlation between lines of business, alternative reinsurance programs, and alternative selections for the Capital Call Cost function which is central to the EVA approach. For those who prefer to measure returns as a percentage of invested capital, a Risk Return on Capital model (RROC) is suggested as an alternative way to integrate desirable properties of the EVA approach and the return on risk adjusted capital (RORAC) approach based upon riskiness leverage models. This method measures returns that are a reward for exposing capital to risk of loss after reflecting the cost of required rating agency capital.