Surrender Contagion in Life Insurance: Modeling and Valuation

Abstract

Mass surrenders—spiking surrenders of life insurance policies within a short period— are widely documented prior to many life insurers failures, but their impacts on insurers are rarely quantified. This paper builds a model of mass surrenders in a heterogeneous pool consisting of a minority of financially guided policyholders and a majority of individual policyholders with contagious behavior that can be triggered contingent on past surrenders becoming salient. By incorporating it into a life insurance pricing framework, we study mass surrenders’ impacts on contract valuation and early bankruptcy of the insurer, allowing for its structural default under regulatory solvency intervention. Our numerical results show that while contagion aligns individual policyholders’ surrender behavior with the optimal surrender of financially guided ones, it jeopardizes their financial positions in favor of equity holders. Surprisingly, contagion at worst only marginally enlarges the insurer’s bankruptcy rate, which is not driven by strict solvency regulation. Insurers have incentives to encourage contagion. Despite its public perception of endangering market stability as similar to a bank run, surrender contagion does not threaten insurers’ solvency, but can improve it instead with the assets left behind by individual policyholders.