Dynamic valuation of insurance cash flows subject to capital requirements

Insurance companies are required by regulation to be in possession of liquid assets that ensure that they can meet their obligations to policyholders with high probability. The amount is usually determined by an actuarial valuation, with for instance the Solvency II regulatory framework providing standard formulae. In this thesis we investigate a valuation procedure where the value of a liability cash flow is determined via a backwards recursive relationship, meaning that the value at time t depends on the value at time t+1. The value corresponds to an amount required to be able to raise capital from an external capital provider with limited liability, in order to meet capital requirements imposed by a regulating body. Paper I describes the valuation philosophy that will more or less be shared by all papers in the thesis. It establishes a recursive relationship given via a mapping, that satisfy the properties of a dynamic monetary utility function. Conditions are given where finite p:th moments are preserved in the recursion and a link to the well known subject of dynamic monetary risk measures and utility functions is established. The structure of the recursion is used to find closed-form values for certain stochastic processes, most importantly in the case where we have jointly Gaussian cash flows. Paper II explores the valuation procedure in the presence of a risk-neutral probability measure, which correctly prices the financial instruments that are priced by the financial market but is also assumed to express the risk aversion toward non-hedgeable insurance risk of the capital provider. We show that the valuation procedure is equivalent to an optimal stopping problem, giving us an alternative way to define the valuation procedure. We reproduce many of the structural results from Paper I under the assumed conditions. We also consider the choice of replicating portfolio under different criteria, especially the criterion of minimizing the need for external capital. Paper III considers the discrete-time valuation from paper I, but where the valuation times form an arbitrary partition of the time interval on which the runoff of the liability occurs. We investigate the properties of the value as the mesh of the partition goes to zero. We define a "continuous-time value" of a liability cash flow and find closed form expressions and some structural results for classes of stochastic processes including Lévy processes and Itô diffusions. Paper IV tackles the nu