The Application Of BMS In Economic Capital Allocation Of Property Insurance Company

Capital allocation is a vital activity for carrying out risk management andeconomic capital management, it also plays an important role in assessing andcomparing the performance, pricing, and strategic decision of the different lines ofbusiness for a property insurance company that writes several lines of business. In themeantime, because each line’s operation is always accompanied with kinds of risks,the capital must be allocated to different lines of business according to the risk leveland the profit for the purpose of cushioning the possible risks. Thereby, Capitalallocation is a core element of the economic capital management in an insurancecompany.However, when the company allocates economic capital to its lines, it mainlyconsiders the loss distribution, while ignoring the number of large losses, especiallythe number of losses exceed expected losses, which can lead to an unfair allocation.Because of bonus-malus system’s advantage in distinguishing heterogeneous risks ofthe covered objects, BMS can solve the problem effectively. Thus, the main purposeof this dissertation is to use BMS in insurance company’s economic capital allocation,thereby provides a new view for an insurance company in designing encouragingcapital allocation technique aiming to perfect its internal risk management mechanismand improve its solvency.This dissertation chooses RMK capital allocation model ground on economic capitalallocation theory. According to bonus-malus system’s advantage in distinguishingheterogeneous risks of the covered objects, effectively solving the problem of unfairallocation, the paper obtains three elements of the bonus-malus system on the basis ofcertain hypothesis, and constructs a bonus-malus system applicable to capitalallocation. Then it makes a property insurance company as an object of the study, usessample data to fit the marginal distribution function of the business lines, andconstructs the dependency structure by a copula function estimated by IFM parametermethod, thus gets the insurance company’s total loss distribution. In the meantime, itsimulates large numbers of data by Monte Carlo and calculates the economic capitalbased on RMK model. In the end, to give the readers an example of this, it takes rule1inthe transition rule for instance, calculates the probability distribution and weightedaverage confidence level in the business lines’ stationary state, and results in the amount of the economic capital adjusted by BMS. We can draw the following conclusions bycomparing with the amount of the economic capital without adjusting by BMS: The totalamount of economic capital decreases, and except for enterprise property insurance andcargo transportation insurance, the amount of the economic capital based on the riskmeasurement VaR and TVaR for other lines also decreases, it means that thenon-adjusting capital allocation method over-estimates the risk, thus over-estimatesthe economic capital.