Risk Coverage Ratio: A Leverage-Independent Method of Pricing based on Distribution of Return

Various approaches have been taken to pricing insurance risk. Recently, a number of authors have written on relationships between insurance pricing and pricing in financial markets. A common central quantity in both insurance and finance is return on equity (ROE). The Risk Coverage Ratio (RCR) is introduced as a risk measure based on the ROE distribution that can be used to price insurance, even for risks that have unusually asymmetric or skewed distributions of return. The RCR calculation is independent of the leverage assumption, which results in pricing that is leverage-independent, a notable advantage. Several other advantages of RCR are discussed. RCR is conceptually related to the Default Rate on Surplus pricing method.

Keywords: ROE, risk criterion, risk measure, risk coverage ratio, leverage, downside risk, upside potential, layer additivity, default rate.