Risk-Based Premiums for Insurance Guaranty Funds

Authors

  • J. DAVID CUMMINS

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    • Wharton School, University of Pennsylvania. The author benefited from valuable comments by Richard Derrig, Andrew Lo, A. S. Paulson, and George Pennacchi on earlier versions of this paper


ABSTRACT

Insurance guaranty funds have been adopted in all states to compensate policyholders for losses resulting from insurance company insolvencies. The guaranty funds charge flat premium rates, usually a percentage of premiums. Flat premiums can induce insurers to adopt high-risk strategies, a problem that can be avoided through the use of risk-based premiums. This article develops risk-based premium formulas for three cases: a) an ongoing insurer with stochastic assets and liabilities, b) an ongoing insurer also subject to jumps in liabilities (catastrophes), and c) a policy cohort, where claims eventually run off to zero. Premium estimates are provided and compared with actual guaranty fund assessment rates.

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