Risk Adjustment for Non-Financial Risk
From a ratemaking perspective, can the risk adjustment for non-financial risk be thought of as the profit margin in the indication formula? Or do they represent different things?
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From a ratemaking perspective, can the risk adjustment for non-financial risk be thought of as the profit margin in the indication formula? Or do they represent different things?
Comments
They are both meant to reflect compensation, but are slightly different - RA is the compensation required to bear the uncertainty around cash flows. Or in other words, extra padding to allow for incorrect assumptions when setting cash flows. Profit margin is something you expect to get above and beyond all your costs, to allow explicitly for insurer profitability.
They are related in the sense that a higher RA would lead to more return required to hit a given target ROE which naturally flows into a higher indication.