Options
Challenges in the Life Insurance Industry with Respect to Pricing and Risk Measurement
Type
fundamental research project
Start Date
01 May 2008
End Date
31 April 2010
Status
ongoing
Keywords
Finance
Insurance
Insurance Groups
Enterprise Risk Management
Risk Measurement
Fair Valuation
Simulation
Swiss Solvency Test
Life Settlement Market
Description
The Swiss life insurance industry plays a fundamental role in the Swiss economy. In 2005, Swiss private life insurers reported a premium volume of 30 billion CHF, thereby managing a capital amount of 120 billion CHF. In recent years, however, several developments in the life insurance industry have led to an increasing interest in valuation and risk measurement of life insurance liabilities, both in the academic world and for practitioners. Among these developments, three major trends can be highlighted that also will have an impact on the life insurance industry in Switzerland.
First, concern about implicit options intensified when the British life insurer Equitable Life had to close to new business in December 2000 due to the neglected pricing of the time value of guaranteed annuity rates. This and other incidents resulted in an increased awareness of the importance of implicit options in life insurance contracts, particularly concerning pricing and adequate risk management. The Swiss insurance industry is especially interested in a market-consistent valuation of liabilities, partly as the result of the ongoing regulatory process and the initiation of the Swiss Solvency Test in 2006. Further, the life settlement market has shown tremendous growth during the last 15 years and still exhibits substantial market potential. However, the benefits and detriments of a secondary market for life insurance for policyholders and insurers are still controversial in the literature. It may thus have a tremendous impact on primary insurers' portfolios due to a possibly larger number of higher-than-average risks (depending on the type of target policy of the secondary market) combined with an altered exercise behavior with respect to implicit options. Finally, there has been a trend toward consolidation in the financial sector of many countries. Financial groups offer benefits in terms of diversification, but they also introduce new sources of risk and risk concentrations. In this context, enterprise risk management and its practicable implementation have become increasingly important in maintaining the strength of insurance groups.
An analysis of these developments will be of high interest, especially for Switzerland due to the importance of the Swiss life insurance industry to the Swiss economy and society. In our research project, we intend to contribute to the analysis of these recent developments by concentrating on central aspects concerning fair valuation, risk assessment, and risk management of life insurance liabilities that have not been analyzed to date. Our goal is to provide valuable information and insight for insurers, policyholders, and regulators.
First, concern about implicit options intensified when the British life insurer Equitable Life had to close to new business in December 2000 due to the neglected pricing of the time value of guaranteed annuity rates. This and other incidents resulted in an increased awareness of the importance of implicit options in life insurance contracts, particularly concerning pricing and adequate risk management. The Swiss insurance industry is especially interested in a market-consistent valuation of liabilities, partly as the result of the ongoing regulatory process and the initiation of the Swiss Solvency Test in 2006. Further, the life settlement market has shown tremendous growth during the last 15 years and still exhibits substantial market potential. However, the benefits and detriments of a secondary market for life insurance for policyholders and insurers are still controversial in the literature. It may thus have a tremendous impact on primary insurers' portfolios due to a possibly larger number of higher-than-average risks (depending on the type of target policy of the secondary market) combined with an altered exercise behavior with respect to implicit options. Finally, there has been a trend toward consolidation in the financial sector of many countries. Financial groups offer benefits in terms of diversification, but they also introduce new sources of risk and risk concentrations. In this context, enterprise risk management and its practicable implementation have become increasingly important in maintaining the strength of insurance groups.
An analysis of these developments will be of high interest, especially for Switzerland due to the importance of the Swiss life insurance industry to the Swiss economy and society. In our research project, we intend to contribute to the analysis of these recent developments by concentrating on central aspects concerning fair valuation, risk assessment, and risk management of life insurance liabilities that have not been analyzed to date. Our goal is to provide valuable information and insight for insurers, policyholders, and regulators.
Leader contributor(s)
Funder(s)
Division(s)
Eprints ID
45203
8 results
Now showing
1 - 8 of 8
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PublicationUnderstanding the Death Benefit Switch Option in Universal Life Policies( 2008)Hoermann, GudrunUniversal life policies are the most popular insurance contract design in the United States. They have either a level death benefit paying a fixed face amount, or an increasing death benefit, which additionally pays the available cash value, and both types include the option to switch from one to the other. In this paper, we are interested in the fact that--unlike a switch from level to increasing--a switch from increasing to level death benefit requires neither fees nor additional evidence of insurability. To assess the impact of the death benefit switch option, we develop a model framework of increasing universal life policies embedding the option. Consideration of mortality heterogeneity via a stochastic frailty factor allows an investigation of adverse exercise behavior. In a comprehensive simulation analysis, we quantify the net present value of the option from the insurer's perspective using risk-neutral valuation under stochastic interest rates assuming empirical exercise probabilities. Based on our results, we provide policy recommendations for life insurers.Type: working paper
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PublicationType: newspaper articleJournal: VersicherungswirtschaftVolume: 62Issue: 10
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PublicationDiversification in Financial ConglomeratesIn an environment of increasingly frequent consolidation activity, the advantages and risks of corporate diversification are of great interest to regulatory authorities, financial group management and management of individual group entities. In general, conglomeration leads to a diversification of risks (the diversification benefit) and to a decrease in shareholder value (the conglomerate discount). Diversification benefits in financial conglomerates are typically derived without accounting for reduced shareholder value, even though a comprehensive analysis requires competitive conditions within the conglomerate, i.e.shareholders and debtholders receive risk-adequate returnsType: newspaper articleJournal: I.VW Management Information - St. Galler Trendmonitor für Risiko- und FinanzmärkteIssue: 2
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PublicationType: newspaper articleJournal: VersicherungswirtschaftVolume: 63Issue: 24
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PublicationOptimal Risk Classification(Institut für Versicherungswirtschaft, 2009-04-15)
;Hoermann, GudrunType: newspaper articleJournal: I.VW Management InformationIssue: 2 -
PublicationA Performance Analysis of Participating Life Insurance ContractsParticipating life insurance contracts are one of the most important products in the European life insurance market. Even though these contract forms are very common, only very little research has been conducted in respect to their performance. Hence, we conduct a performance analysis to provide a decision support for policyholders. We decompose a participating life insurance contract in a term life insurance and a savings part and simulate the cash flow distribution of the latter. Simulation results are compared with cash flows resulting from two benchmarks investing in the same portfolio of assets but without investment guarantees and bonus distribution schemes, in order to measure the impact of these two product features. To provide a realistic picture within the two alternatives, we take transaction costs and wealth transfers between different groups of policyholders into account. We show that the payoff distribution strongly depends on the initial reserve situation and managerial discretion. Results indicate that policyholders will in general profit from a better payoff distribution of the participating life insurance compared to a mutual fund benchmark but not compared to an exchange-traded fund benchmark portfolio.Type: journal articleJournal: Insurance: Mathematics and EconomicsVolume: 51Issue: 1
Scopus© Citations 7 -
PublicationRisk and Capital Transfer in Insurance GroupsThe aim of this paper is to analyze the effect of capital and risk transfer instruments (CRTIs) on a financial group's risk situation. In this respect, we extend previous literature by accounting for the conglomerate discount on firm value, which is a reduction in shareholder value due to diversification within the group. In general, CRTIs between parent and subsidiaries have a substantial effect on the diversification of risks, economic capital requirements, and default risk, which we study in detail for different types of CRTIs, including intra-group retrocession and guarantees. One main finding is that diversification effects within the group are much lower when taking into account conglomerate discount effects. We believe this aspect to be an important issue in the ongoing discussion on group solvency regulation and enterprise risk management.Type: journal articleJournal: Zeitschrift für die gesamte VersicherungswissenschaftVolume: 97Issue: 4
Scopus© Citations 1 -
PublicationThe Impact of the Secondary Market on Life Insurers' Surrender Profits(American Risk and Insurance Association, Inc., 2009-12)
;Hoermann, GudrunLife insurers often claim that the life settlement industry reduces their surrender profits and leads to an adverse shift in their portfolio of insured risks, i.e., bad risks remain in the portfolio instead of surrendering. In this paper, we aim to quantify the effect of altered surrender behavior--subject to the health status of an insured--in a portfolio of life insurance contracts on the surrender profits of primary insurers. Our model includes mortality heterogeneity by applying a stochastic frailty factor to a mortality table. In the course of our investigation, we additionally analyze the impact of the premium payment method by comparing results for annual and single premium payments.Type: journal articleJournal: Journal of Risk and InsuranceVolume: 76Issue: 4Scopus© Citations 24