Combining Fair Pricing and Capital Requirements for Non-Life Insurance Companies

The aim of this article is to identify fair equity-premium combinations for non-life insurers that satisfy solvency capital requirements imposed by regulatory authorities. In particular, we compare "target capital" derived using the "value at risk" concept as planned for Solvency II in the European Union with the "tail value at risk" concept as required by the Swiss Solvency Test. The model framework uses Merton's jump-diffusion process for the market value of liabilities and a geometric Brownian motion for the asset process; valuation is conducted using option pricing theory. In this setting, we study the impact of model parameters and corporate taxation on fair pricing, solvency capital requirements, and shortfall probability for different safety levels measured by the default put option value. We show that even though corporate taxes can have a substantial impact on pricing and capital structure, they do not affect capital requirements if the safety level is retained before and after taxation.