On the Expected Maximum Deficit and the Optimal Allocation of Reserves

TL;DR

This paper introduces risk measures based on the expected maximum deficit and develops optimal reserve allocation strategies across multiple insurance lines, with theoretical properties and dynamic extensions.

Contribution

It formalizes the expected maximum deficit as a risk measure, introduces bounded risk measures, and provides analytical solutions for optimal capital allocation.

Findings

Established static coherence and convexity properties.

Developed dynamic supermartingale extensions for capital requirements.

Derived exact analytical solutions for aggregate minimum reserve.

Abstract

This paper investigates risk measures derived from the expected maximum deficit in a continuous-time framework and develops optimal reserve allocation strategies across multiple lines of business. We formalize the expected maximum deficit and study its associated distortion risk measures. Furthermore, we introduce implicitly bounded risk measures based on the minimal capital required to meet prescribed fixed and proportional risk tolerances, and propose approaches for optimal capital allocation using line-specific distorted expected deficits. Theoretical results established include static coherence and convexity properties, dynamic conditional extensions detailing supermartingale time consistency over a fixed horizon and the evolution of capital requirements across rolling horizons, and exact analytical optimizations of the aggregate minimum reserve.