Pragmatic Insurance Option Pricing

This paper deals with theoretical and practical pricing of non-life insurance contracts within a financial option pricing context. The market based assumption approach of the option context fits well into the practical nature of non-life insurance pricing and valuation. Basic facts in most insurance markets like the existence of quite different insurer price offers on the same claims risk in the same market, support the need for this approach. The paper outlines insurance and option pricing in a parallel setup. First it takes a complete market approach, focusing dynamic hedging, no-arbitrage and risk-neutral martingale valuation principles within insurance and options. Secondly it takes an incomplete market view by introducing supply and demand effects via purchasing preferences in the market. Finally the paper discusses pragmatic insurance price models, parameter estimation techniques and international best practice of insurance pricing. The overall aim of the paper is to describe and unite the headlines of the more or less common insurance and option price theory, and hence increase the pragmatic understanding of this theory from a business point of view.

Keywords: Insurance and financial option contracts; insurance and option pricing theory; complete and incomplete markets; dynamic hedging and no-arbitrage; risk-neutral martingales; purchasing preferences; risk, cost and market price adjustments; parameter estimation; pragmatic and best practice pricing.