CAS Exam 9 Spring 2015, Question 15
Study guide: Exam 9
An insurance company is considering investing in only one new line of business. The company will base its decision on one of two risk measures: either the economic profit or the risk-adjusted return on capital (RAROC). The options are summarized in the table below:
| Line A | Line B | |
|---|---|---|
| Premium | $10,000,000 | $8,000,000 |
| Expense Ratio | 10% | 15% |
| Loss Ratio | 80% | 75% |
| Required Capital | $9,500,000 | $4,500,000 |
- Investment return is 6.5%.
- Premium is collected immediately.
- Expenses are paid immediately.
- Capital is released at the end of the year.
- Losses are paid at the end of the year.
Part a (1.5 points)
Demonstrate which line would be preferred for each of the risk measures.
Part b (0.5 points)
Calculate the additional premium that would need to be charged for line A to make its risk-adjusted return on capital equal to line B. Assume the required capital for line A does not change.
Answer this question and see the worked solution