On the Risk of Life Insurance Liabilities: Debunking Some Common Pitfalls

The objective of this paper is to contribute to a better understanding of the driving forces of a life insurance company. More specifically, the issues of the duration and convexity of insurance liabilities and equity are addressed. These issues deserve a careful rethinking given the recent trends that have affected the insurance landscape. A correct assessment of these risk measures is critical as they constitute the primary ingredients of any sound asset-liability management approach. In addition, the effort toward a more detailed and more accurate risk picture of life insurance operations enables one to debunk some pitfalls that are commonly encountered in the insurance industry. This paper was presented at the Financial Institutions Center's May 1996 conference on "

Demande d’assurance, décisions de consommation et de portefeuille : une analyse en temps continu

Cet article examine la demande optimale d’assurance dommage en temps continu. Les décisions d’assurance, de portefeuille et de consommation sont analysées conjointement dans un cadre à la Merton (1969, 1971). Des solutions explicites sont dérivées dans le cas d’une fonction d’utilité isoélastique. Il apparaît que les propriétés de la demande optimale d’assurance sont bien plus complexes que ne le laissent supposer certaines récentes contributions.This paper provides a continuous-time analysis of the optimal insurance demand by individuals. A joint treatment of the insurance, consumption and portfolio decisions is presented using a framework à la Merton (1969, 1971). The individual optimal insurance demand is explicitly derived under the class of isoelastic marginal utility fonctions. It is shown that the properties of the optimal insurance coverage are far more complex than suspected by some recent contributions. In the course of doing so this paper tries to fill a gap of the traditional insurance literature which has very often focused on insurance in isolation

The impact of longevity and investment risk on a portfolio of life insurance liabilities

In this paper we assess the joint impact of biometric and financial risk on the market valuation of life insurance liabilities. We consider a stylized, contingent claim based model of a life insurance company issuing participating contracts and subject to default risk, as pioneered by Briys and de Varenne (Geneva Pap Risk Insur Theory 19(1):53–72, 1994, J Risk Insur 64(4):673–694, 1997), and build on their model by explicitly introducing biometric risk and its components, namely diversifiable and systematic risk. The contracts considered include pure endowments, deferred whole life annuities and guaranteed annuity options. Our results stress the predominance of systematic over diversifiable risk in determining fair participation rates. We investigate the interaction of contract design, market regimes and mortality assumptions, and show that, particularly for lifelong benefits, the choice of the participation rate must be very conservative if longevity improvements are foreseeable

Production and Hedging under Smooth Ambiguity Preferences

This paper examines the optimal production and hedging decisions of the competitive firm facing ambiguous price and background risk. Ambiguity is modeled by a second-order probability distribution that captures the firm's uncertainty about which of the subjective beliefs govern the price and background risk. Ambiguity preferences are modeled by the (second-order) expectation of a concave transformation of the (first-order) expected utility of profit conditional on each plausible subjective joint distribution of the price and background risk. When the background risk is additive in nature, we show that the separation theorem holds in that the firm's optimal production decision depends neither on the firm's attitude towards ambiguity nor on the incident of the underlying ambiguity. We derive necessary and sufficient conditions under which the firm's optimal forward position is completely characterized. When the background risk is multiplicative in nature, we derive sufficient conditions under which the firm reduces its optimal output level and opts for an under-hedge. Contrary to the conventional wisdom, we show that the behavior of the firm is affected by the introduction of ambiguity even when the firm is ambiguity neutral.postprin

The Spot-Forward Exchange Rate Relation in Indian Foreign Exchange Market An Analysis

Forward exchange rate bias explanation generally falls into two categories – assumption of rational expectation resulting in a risk premium and expectation errors which is systematic. The paper tests the bias in the Indian forward exchange markets using one-month and three month forward contracts. The study finds that the three month contracts have larger prediction errors than the one-month contracts. The also paper finds that the prediction errors have information content which leads to assume the presence of risk premium. The study also finds that risk one-month contracts have lesser variability vis-à-vis the three month contracts