The Cost of Goods Sold: Determining the Cost of Capital for Insurance Risk by Line

This session will explain how to load loss costs for risk. It will compare traditional methods (constant ROE, endless debate about allocation) with distortion, or spectral, risk measure approaches (variable cost of capital, but unique allocation). It will apply the theory to a notional portfolio. It will highlight that diversification, relative tail thickness by line, and limited liability interact in subtle ways to produce the final answer.

Distortion methods will be shown to correspond directly to differential costs of capital across a realistic capital structure. The theory will be applied to reinsurance purchasing strategy and retention setting.

  • Date:Wednesday, June 9
  • Time:1:15 PM - 2:30 PM Eastern Daylight Time
  • Session Type:Concurrent Session
  • Session Code:CS24
  • Learning Objective 1::Distinguish capital from equity; Compute the weighted average cost of capital; Explain why equity capital is expensive
  • Learning Objective 2::Describe and apply traditional methods to adding the cost of capital; Describe and apply distortion-based methods
  • Learning Objective 3::Apply pricing methods on a stand-alone and pooled basis; Understand how you expect different methods to act; Validate understanding on a notional portfolio
  • Level of Knowledge:Level 2: General knowledge of the subject
  • Moderator:Andy Feng
Stephen Mildenhall
Convex Risk LLC
John Major