This paper provides a closed form solution for the value of a multiple claim insurance contract that is subject to a deductible amount and/or an upper limit on claims. The solution is a time integral of European option prices. The model provides three important insights. First, systematic risk in insurance policies is altered in the presence of deductibles and maximum indemnity levels. Second, idiosyncratic risk affects policy valuation and the required rates of return on underwriting portfolios. Finally, contrary to traditional actuarial intuition, changes in the risk-free interest rate may either increase or reduce policy values.

ABSTRACT This paper values a contingent claim to discrete stochastic cash flows generated by a Poisson arrival process with a randomly varying intensity parameter. In the most general case, both the size and the arrival intensity of cash flows may correlate wih state variables in a continuous time economy. Assuming the conditions of an intertemporal capital aset pricing model, solutions for the value of the contingent claim can be found using various techniques. The paper suggests immediate applications to the valuation of insurance contracts, the decision to build a firm with unknown future investment opportunities, and the pricing of mortgage‐backed securities.

This brief primer is intended to provide the foundations for the study of more rigorous and lengthy texts. It is designed principally for the finance faculty which does not specialize in continuous time methods, PhD students in finance and finance professionals. Chapters cover: a paradigm for primary asset valuation; complications of the basic paradigm; the valuation of derivative securities; optimal decision strategies and valuation.