Solvency analysis and demographic risk measures

Abstract

PurposeThe demographic risk is the risk due to the uncertainty in the demographic scenario assumptions by which life insurance products are designed and valued. The uncertainty lies both in the accidental (insurance risk) and systematic (longevity risk) deviations of the number of deaths from the value anticipated for it. This last component gives rise to the risk due to the randomness in the choice of the survival model for valuations (model risk or projection risk). If the insurance risk component can be assumed negligible for well‐diversified portfolios, as in the case of pension annuities, longevity risk is crucial in the actuarial valuations. The question is particularly decisive in contexts in which the longevity phenomenon of the population is strong and pension annuity portfolios constitute a meaningful slice of the financial market – both typical elements of Western economies. The paper aims to focus on the solvency appraisal for a portfolio of life annuities, deepening the impact of the demographic risk according to suitable risk indexes apt to describe its evolution in time.Design/methodology/approachThe financial quantity proposed for representing the economic wealth of the life insurance company is the stochastic surplus, and the paper analyses the impact on it of different demographic assumptions by means of risk indicators as the projection risk index, the quantile surplus valuation and the ruin probability. By means of the proposed models, the longevity risk is mainly taken into account in a stochastic scenario for the financial risk component, in order to consider their interactions, too. In order to furnish practical details significant in the portfolio risk management, several numerical applications clarify the practical meaning of the models in the solvency context.FindingsThis paper studies the impact on the portfolio surplus of the systematic demographic risk, taking into account their interaction with the financial risk sources. In this order of ideas, the internal risk profile of a life annuity portfolio is deeply investigated by means of suitable risk indexes: in a solvency analysis perspective, some possible scenarios for the evolution of death rates (generated by different survival models) are considered and this paper evaluates the impact on the portfolio surplus caused by different choices of the demographic model. The first index is deduced by a variance decomposition formula, the other ones involve the conditional quantile calculus and the ruin probability. Such indexes constitute benchmarks, whose conjoined use provides useful information to the meeting of the solvency requirements.Originality/valueWith respect to the recent actuarial literature, in which the most important contribution on the surplus analysis has been given by Lisenko et al. – where the analysis focuses on the financial aspect applied to portfolios of temporary and endowment contracts – the paper considers life annuity portfolios, taking into account the effect of the systematic demographic risk and its interactions with the financial risk components.