Optimization Models for Insurance Portfolio Optimization in the Presence of Background Risk

The liability stream of insurance companies often stretches several years into the future. Therefore, there is always the need to determine a portfolio of bonds or other assets whose cash-flows replicate those of the liability stream. Insurance regulatory authorities require that insurance companies must demonstrate solvency. To achieve this, an insurance company needs to determine a fair market value of its liability by finding a replicating portfolio consisting of default-free bonds. This paper presents a class of optimization models that could be employed for portfolio optimization in the presence of background risk.