Pricing and Capital Allocation for Multiline Insurance Firms

We study multiline insurance companies with limited liability and limited capital, creating the possibility of insurer default. Insurance premiums are determined by no-arbitrage option pricing methods. The results are developed under the realistic assumption that the losses created by insurer default are allocated among policyholders following an ex post, pro rata, sharing rule. In general, the ratio of default costs to expected claims, and thus the ratios of premiums to expected claims vary across insurance lines. Moreover, capital and related costs are allocated across lines in proportion to each line’s share of a digital default option on the insurer. Our results differ from those derived elsewhere in the literature.