Insurance Risk, Risk Measures, and Capital Allocation: Navigating a Copernican Shift

Abstract

We pursue two interrelated lines of thought. The first is a conceptual arc from (a) consideration of the unique characteristics of insurance risk, to (b) the quantification of this risk through risk measures, to (c) the application of these concepts to problems of allocating capital within an insurance company. The second is the identification and analysis of a dichotomy between prescriptive and descriptive approaches that appears in the study of each of the three previous components. In this way, we demonstrate the need for a Copernican shift from prescriptive solutions emphasizing the intrinsic characteristics of insurance loss random variables, to descriptive solutions accounting for both the properties of loss distributions and the economic and regulatory realities faced by insurance companies.