Analysis Of Option Pricing Of Insurance Under Solvency Capital Requirement

Since the insurance contracts are regarded as a kind of financial derivatives, the option pricing theory could be applied to decide the insurance fair rates based on no-arbitrage principle. This paper discusses the fair rates of option pricing approach when insurance pricing takes firm insolvency risk into account, and also how target requirements affect the fair pricing. The insolvency risk is estimated with two different risk measurements for the perspectives of companies and regulator.First, this paper discusses the importance of economic balance sheet, which should follow the principle of market consistent embedded value. Then, the paper analyses the payoffs of both policyholders and shareholders in one-period discrete model based on the assumptions of shareholders limited liability, and firm overall insolvency risk. The fair rates for both stakeholders could be derived by applying the Black-Scholes option pricing formula.Furthermore, the paper discusses whether the amount of company’s risk-based capital satisfies the target requirements or not by using solvency capital requirements under Solvency Ⅱ and SST. For a set of asset and liability model and the initial liability, the paper analyses the upper limit of default option value which represents the insolvency risk under the target requirements by shifting the value of default option. In addition, the paper compares the results for liability models with and without a jump component.