Abstract
ABSTRACTThis paper provides a method to assess the risk relief deriving from a foreign expansion by a life insurance company. We build a parsimonious continuous-time model for longevity risk that captures the dependence across different ages in domestic versus foreign populations. We calibrate the model to portray the case of a UK annuity portfolio expanding internationally toward Italian policyholders. The longevity risk diversification benefits of an international expansion are sizable, in particular when interest rates are low. The benefits are judged based on traditional measures, such as the Risk Margin or volatility reduction, and on a novel measure, the Diversification Index.
Highlights
In the last 20 years, insurance companies have been expanding internationally, via subsidiaries operating in different countries or via cross-border mergers and acquisitions
Cummins et al (1999) argue that geographical diversification was a primary determinant of mergers and acquisitions in the US insurance industry in the nineties because geographically diversified firms were more likely to be the target of acquisitions
We introduce and compute a novel diversification index, which can be defined thanks to our longevity model, because it stems from the correlation structure of different populations and cohorts within them
Summary
In the last 20 years, insurance companies have been expanding internationally, via subsidiaries operating in different countries or via cross-border mergers and acquisitions. The present paper aims at filling a gap in the literature by showing that the standard, solvency-based measures of riskiness can be lowered, especially in low-interest-rate environment, thanks to longevity diversification, and that even non-VaR-based risk decreases. To this end, we first introduce a novel parsimonious model for the joint mortality dynamics of policyholders in different countries. Based on our model estimates, we compute our international diversification measures for different portfolio expansions. Appendix A details the Gaussian mapping technique used to estimate the correlation structure, while Appendix B compares two ways of achieving the international diversification: a physical one, in which a foreign affiliate is opened, and a synthetic one, through a longevity swap
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