Pricing for Credit Exposure

This paper incorporates financial theory with insurance pricing. A general procedure to price for credit exposure has been developed and extended to several insurance products. For retrospectively rated insureds with a below-investment-grade rating from a credit rating agency, the credit exposure is significant to the insurer. If this exposure is ignored, operating results may be negatively affected, as it is likely that some additional premium amounts will not be collected. The principles of credit exposure pricing can be extended to the pricing of surety bonds as outlined in Section 6. In addition, the concepts outlined in this paper may be used to: 1. establish a bad debt reserve for GAAP statements; 2. provide insurance regulators with an additional method to determine collateral requirements; 3. estimate surety bond loss ratios; and 4. provide banks with an additional methodology to price letters of credit which collateralize unpaid claim liabilities.