Mildenhall Ch 13: Classical Price Allocation Practice

Question 1

Calculate Unit Margin

Answer 1

Unit Margin = Unit Premium - Unit Losses

Question 2

Calculate Unit Capital

Answer 2

Unit Capital = Unit Assets - Unit Premium

Question 3

Calculate Unit Rate of Return

Answer 3

Unit Rate of Return = Unit Margin / Unit Capital

Question 4

Calculate Unit Leverage

Answer 4

Unit Leverage = Unit Premium / Unit Capital

Question 5

Briefly describe a major criticism of Allocated CCoC pricing

Answer 5

It is criticized for being heavily weighted towards tail risk (tends to allocate higher capital amounts to business that are heavily skewed).

The heavy weighting to tail risk is caused by choice of capital risk measure and by applying same CoC to all capital layers.

Although a focus on tail risk is good from a regulatory standpoint since extreme events can cause insolvency. It is less useful for managing interests of firm’s stakeholders.

Our ultimate goal is to allocate to each unit the capital it actually consumes.

Question 6

Comment on allocation of classical PCP Pricing.

Answer 6

We can allocate premiums (PCPs) directly.

However, in practice, classical PCPs are usually applied on a stand-alone basis.

Thus, allocation is not necessary.