Pricing of Adverse Development Cover Using Option Pricing Methods

The market for Adverse Development Cover and Loss Portfolio Transfer has been growing in the past few years. Despite this growth, reinsurers are still struggling to define a standard method for pricing such covers. In this context, this article aims at providing an innovative method for pricing such contracts. The proposed method is based on the famous Mack model (see Mack 1993) and fits a Constant Elasticity of Variance (hereinafter “CEV”) model to the Mack results (expected value and standard deviation) on each future development year of each accident/underwriting year. Having fitted the CEV model, it is possible to estimate the value of the Adverse Development Cover for each accident/underwriting year using standard European option pricing techniques and to compare this valuation to usual General Insurance valuation techniques