My understanding is: The capital occupation cost is like a risk-free return required by holding capital in safe instruments, while the capital call cost is an additional return to compensate for the risk of writing insurance business, i.e. Risk of eroding the capital. The sum of these two components will be the cost of capital for the business. Is this correct?
Capacity occupation cost is an opportunity cost that compensates the company for missing out on other opportunities. By holding capital in safe investments, a company expects to make a lower return than it would if it were able to invest the funds more freely. It is a non-consumptive use of capital. Capital call cost compensates for the potential erosion of capital in order to make claim payments. The amount of the charge depends on the likelihood of such a transfer being necessary as well as the likely amounts involved. It is a consumptive use of capital. From acted X-series answers
That's word for word from the course notes. I'd like to know if there is another way to look at them.
1) Capactiy occuption would be the premium above the risk-free rate to cater for the opportunity cost of not being invested in risky asset. 2) Capital call cost would be the premium required to the investor to cater for the fact that intial capital might be lost if technical reserves are insufficient to pay for claims. In short, risk premium for risk for capital loss.
