Diversification credit

Central estimates and risk margins are typically determined for each line of business (LoB) of an insurer. Simply adding these liability provisions together provides an overall provision, but is only appropriate in the circumstance that there is 100% correlation between all of the lines of business. In all likelihood, not all lines of business will develop in the same way at the same time. Adverse development in one line of business may be offset by favourable development in another. Or, an external factor influencing one line of business might influence another line of business in the same direction, but to a lesser extent or at a different rate.

In other words, most insurers have diversified insurance portfolios. If this is the case, the provision required for the insurer overall at a given probability of sufficiency, is less than the sum of the provisions for each line of business at the same probability of sufficiency. This difference is referred to as "diversification credit" or "diversification benefit".