Risk-based capital for credit insurers with business cycles and dynamic leverage |
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Authors: | Issouf Soumaré Ernest Tafolong |
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Affiliation: | 1. Faculty of Business Administration, Laboratory for Financial Engineering and Department of Finance, Insurance and Real Estate, Laval University, Quebec, Quebec, G1V 0A6, Canada.;2. Market Risks Quantification, National Bank of Canada, Montreal, Quebec, H3B 5G2, Canada. |
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Abstract: | This paper develops a risk-based capital pricing model for credit insurance portfolios held by a vulnerable insurer. The model accounts for business cycles using a two-state Markov switching model, and allows for dynamic leverage adjustment by the insured firms. The new proposed model, which incorporates risk-based capital practice, is better for both the insurer and the insured firms. Based on the risk-adjusted performance metric, we found that the insurer is better off insuring short- and medium-term loans in expansion and steady states, while it is better off backing both short- and long-term loans in recessions. Our results also emphasize that macroeconomic uncertainty significantly impairs the creditworthiness of the insurer and insured firms. |
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Keywords: | Credit insurance Business cycles Capital allocation Risk-based capital Guarantee |
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