Risk‐Based Premiums for Insurance Guaranty Funds

TLDR

Insurance guaranty funds, adopted in all states, compensate policyholders for losses from insurer insolvencies and currently charge flat premium rates that can encourage high‑risk strategies. The study aims to develop risk‑based premium formulas for insurers with stochastic assets and liabilities, insurers subject to catastrophic jumps, and policy cohorts whose claims eventually run off to zero. The authors derive explicit premium formulas for each scenario, enabling calculation of risk‑based premiums. Premium estimates are provided and compared with actual guaranty fund assessment rates.

Abstract

ABSTRACT Insurance guaranty funds have been adopted in all states to compensate policyholders for losses resulting from insurance company insolvencies. The guaranty funds charge flat premium rates, usually a percentage of premiums. Flat premiums can induce insurers to adopt high‐risk strategies, a problem that can be avoided through the use of risk‐based premiums. This article develops risk‐based premium formulas for three cases: a) an ongoing insurer with stochastic assets and liabilities, b) an ongoing insurer also subject to jumps in liabilities (catastrophes), and c) a policy cohort, where claims eventually run off to zero. Premium estimates are provided and compared with actual guaranty fund assessment rates.