Investment-Equivalent Reinsurance Pricing

Reinsurance pricing is usually described as market-driven. In order to have a more theoretical (and practical) basis for pricing, some description of the economic origin of reinsurance risk load should be given. A special-case algorithm is presented here that allows any investment criteria concerning return and risk to be applied to a combination of reinsurance contract terms and financial techniques. The inputs are the investment criteria, the loss distributions, and a criterion describing a reinsurer's underwriting conservatism. The outputs are the risk load and the time-zero assets allocated to the contract when it is priced as a stand-alone deal. Since most reinsurers already have a book of business and hence contracts mutually support each other, the risk load here can be regarded as a reasonable maximum. The algorithm predicts the existence of minimum premiums for rare event contracts, and generally suggests a reduction in risk load for poling across contracts and/or years. Three major applications are: (1) pricing individual contracts, (2) packaging a reinsurance contract with financial techniques to create an investment vehicle, and (3) providing a tool for whole book management using risk and return to relate investment capital, underwriting, and pricing.