On the interaction between insurance risk, market risk and capital allocation in the insurance sector

Abstract

This paper presents a model in which the effects of insurance risk on external (market) risk and internal (capital allocation related) risk can be compared. The model highlights that the composition of the insurance portfolio within an insurance group may not only affect internal capital allocation and performance measures, but also market risk and thus theoretical investment decisions. The main research question of the paper is whether external (market) and internal risk measures depend similarly on insurance risk. The paper aims at contributing to previous literature with theoretical results suggesting that, depending on the size of insurance risk, a change in insurance risk correlation may be accompanied by similar or opposite modifications in market risk and internal risk.