Assessing Investment and Longevity Risks within Immediate Annuities

Life annuities provide a guaranteed income for the remainder of the recipient’s lifetime, and therefore, annuitization presents an important option when choosing an adequate investment strategy for the retirement ages. While there are numerous research articles studying annuities from a pensioner’s point of view, thus far there have been few contributions considering annuities from the provider’s perspective. In particular, to date there are no surveys of the general risks within annuity books. The present paper aims at filling this gap: Using a simulation framework, it provides a long-term analysis of the risks within annuity books. In particular, the joint impact of mortality risks and investment risks as well as their respective influences on the insurer’s financial situation are studied. The key finding is that, under the model specifications and using annuity data from the United Kingdom, the risk premium charged for aggregate mortality risk seems to be very large relative to its characteristics. Possible reasons as well as economic implications are provided, and potential caveats are discussed

Climate Change, Insurability of Large-scale Disasters and the Emerging Liability Challenge

This paper focuses on the interaction between uncertainty and insurability in the context of some of the risks associated with climate change. It discusses the evolution of insured losses due to weather-related disasters over the past decade, and the key drivers of the sharp increases in both economic and insured catastrophe losses over the past 20 years. In particular we examine the impact of development in hazard-prone areas and of global warming on the potential for catastrophic losses in the future. In this context we discuss the implications for insurance risk capital and the capacity of the insurance industry to handle large-scale events. A key question that needs to be addressed is the factors that determine the insurability of a risk and the extent of coverage offered by the private sector to provide protection against extreme events where there is significant uncertainty surrounding the probability and consequences of a catastrophic loss. We discuss the concepts of insurability by focusing on coverage for natural hazards, such as earthquakes, hurricanes and floods. The paper also focuses on the liability issues associated with global climate change, and possible implications for insurers (including D&O), given the difficulty in identifying potential defendants, tracing harm to their actions and apportioning damages among them. The paper concludes by suggesting ways that insurers can help mitigate future damages from global climate change by providing premium reductions and rate credits to companies investing in risk-reducing measures.

Integrated asset liability modelling for property casuality insurance : a portfolio theoretical approach

In this paper we have developed a financial model of the non-life insurer to provide assistance for the management of the insurance company in making decisions on product, investment and reinsurance mix. The model is based on portfolio theory and recognizes the stochastic nature of and the interaction between the underwriting and investment income of the insurance business. In the context of an empirical application we illustrate howa portfolio optimisation approach can be used for asset-liability management

Mortality-Indexed Annuities

Longevity risk has become a major challenge for governments, individuals, and annuity providers in most countries, and especially its aggregate form, i.e. the risk of unsystematic changes to general mortality patterns, bears a large potential for accumulative losses for insurers. As obvious risk management tools such as (re)insurance or hedging are less suited to manage an annuity provider’s exposure to aggregate longevity risk, the current paper proposes a new type of life annuities with benefits contingent on actual mortality experience, and it also details actuarial aspects of implementation. Similar adaptations to conventional product design exist in investment-linked annuities, and a role model for long-term contracts contingent on actual cost experience is found in German private health insurance so that the idea is not novel in general, but it is in the context of longevity risk. By not or re-transferring the systematic longevity risk insurers may avoid accumulative losses so that the primary focus in an extensive Monte-Carlo simulation is on the question of whether and to what extent such products are also advantageous for policyholders in contrast to a comparable conventional annuity product

Assessing Investment and Longevity Risks within Immediate Annuities

Life annuities provide a guaranteed income for the remainder of the recipient’s lifetime, and therefore, annuitization presents an important option when choosing an adequate investment strategy for the retirement ages. While there are numerous research articles studying annuities from a pensioner’s point of view, thus far there have been few contributions considering annuities from the provider’s perspective. In particular, to date there are no surveys of the general risks within annuity books. The present paper aims at filling this gap: Using a simulation framework, it provides a long-term analysis of the risks within annuity books. In particular, the joint impact of mortality risks and investment risks as well as their respective influences on the insurer’s financial situation are studied. The key finding is that, under the model specifications and using annuity data from the United Kingdom, the risk premium charged for aggregate mortality risk seems to be very large relative to its characteristics. Possible reasons as well as economic implications are provided, and potential caveats are discussed.Annuities; Lee-Carter Model; Longevity Risk

Longevity Risk and Natural Hedge Potential in Portfolios Of Life Insurance Products: The Effect of Investment Risk

Payments of life insurance products depend on the uncertain future evolution of survival probabilities. This uncertainty is referred to as longevity risk. Existing literature shows that the effect of longevity risk on single life annuities can be substantial, and that there exists a (natural) hedge potential from combining single life annuities with death benefits or from investing in survivor swaps. The effect of financial risk on these hedge effects is typically ignored. The aim of this paper is to quantify longevity risk in portfolios of mortality-linked assets and liabilities, taking into account the effect of financial risk. We find that investment risk significantly affects the impact of longevity risk in life insurance products. It also significantly affects the hedge potential that arises from combining life insurance products, or from investing in longevity-linked assets. For example, our results suggest that ignoring the effect of financial risk can lead to severe overestimation of the natural hedge potential from death benefits, and underestimation of the hedge effects of survivor swaps.Life insurance;life annuities;death benefits;survivor swaps;risk management;financial risk;longevity risk;insolvency risk;capital adequacy

The current value of the mathematical provision: a financial risk prospect

The paper addresses the question of the calculation of the current value of the mathematical provision and moulds it in a deterministic and stochastic scenario, using a proper term structure of interest rates estimated by means of a Cox-Ingersoll-Ross model. It provides a complete and original year-by-year evaluation model for the business performance, and a closed solution for the current evaluation of the reserve, together with a comprehensive insight into the dynamics of the reserve connected to the selection of a defined term structure of interest rates. Moreover, the calculation of the VaR of the mathematical provision is prospected as risk measure useful to appreciate also the evaluation rate risk. Future research prospects concern the selection of the stochastic process used to describe the dynamics of the interest rates and the possible managerial and regulatory application of a VaR measure. The modelling has been applied, as an exemplification, to a life annuity portfolio but it can be easily replicated for any kind of policy and any kind of portfolios even non homogeneous.Risk indicators, life insurance, solvency, financial risk, demographic risk

Risk pricing practices in finance, insurance and construction

A review of current risk pricing practices in the financial, insurance and construction sectors is conducted through a comprehensive literature review. The purpose was to inform a study on risk and price in the tendering processes of contractors: specifically, how contractors take account of risk when they are calculating their bids for construction work. The reference to mainstream literature was in view of construction management research as a field of application rather than a fundamental academic discipline. Analytical models are used for risk pricing in the financial sector. Certain mathematical laws and principles of insurance are used to price risk in the insurance sector. construction contractors and practitioners are described to traditionally price allowances for project risk using mechanisms such as intuition and experience. Project risk analysis models have proliferated in recent years. However, they are rarely used because of problems practitioners face when confronted with them. A discussion of practices across the three sectors shows that the construction industry does not approach risk according to the sophisticated mechanisms of the two other sectors. This is not a poor situation in itself. However, knowledge transfer from finance and insurance can help construction practitioners. But also, formal risk models for contractors should be informed by the commercial exigencies and unique characteristics of the construction sector

Valuation in insurance and financial crisis.

In the course of the recent financial crisis, the issue of asset valuation has regularly moved to center stage, due both to the sharp fluctuations observed in numerous assets, making economic measurement difficult, but also to the impact that fluctuations can have on the behaviour of economic agents that are required to submit annual financial statements –or even interim or quarterly ones. While this issue has not been seen as the cause of the latest crisis, it has nonetheless been considered as a potential source of its increasing magnitude, even though –at the time of this writing (early July)– we have not yet seen any massive sell-offs of major asset classes (equities or bonds, corporate issues in particular). The question of asset and liability valuation is of particular concern for the insurance industry. Because of the specific characteristics of this industry, valuation poses specifi c problems which, far from being fully different compared to the other sectors –the banking industry in particular– in fact tend to be magnified. In fact, it is no accident that the only sector to be granted a transition regime in the application of new international accounting standards is the insurance industry, due to difficulties encountered by the International Accounting Standards Board (IASB) in finding a workable solution for the valuation of insurance liabilities. Similarly, it is no accident that the Internet meltdown was suddenly aggravated in 2002-2003 by the massive move on the part of insurance and reinsurance companies to liquidate their equity portfolios when, once a certain downward price threshold had been surpassed, they decided it was time to sell rather than face the consequences of further depreciation in equity prices on their balance sheets and their solvency margins. The memory of this last event, which without any warning whatsoever took on the proportions of a systemic risk for the global fi nancial sector, recently came to mind when the fall in equity prices picked up speed globally in light of soaring oil prices and an uptick in infl ation. Accordingly, the issue of insurance asset and liability valuation does not just pose a microeconomic problem in terms of assessing the financial strength of insurance and reinsurance companies. It also poses a macroeconomic problem in terms of financing the economy and ensuring financial stability. In the rest of this article, we will examine the economic problems posed by the valuation of insurance and reinsurance assets and liabilities. Then, we will analyse the relevance of today’s competing accounting standards, concluding that they offer a very imperfect resolution to the challenges of insurance valuation. Finally, we will analyse the consequences of these problems for financial stability –in terms of the solvency of companies, the financing of the economy, and the ability to absorb shocks to the system. We will conclude that they are signifi cantly greater than is often imagined.