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 emphasise that macroeconomic uncertainty significantly impairs the creditworthiness of the insurer and insured firms.
This is an output from the ‘Delivering Inclusive Financial Development and Growth’ project
Issouf Soumaré & Ernest Tafolong (2016) Risk-based capital for credit insurers with business cycles and dynamic leverage,Quantitative Finance, 17:4, 597-612
Risk-Based Capital for Credit Insurers with Business Cycles and Dynamic Leverage