With-profit Policies Research Articles

Quantitative assessment of common practice procedures in the fair evaluation of embedded options in insurance contracts

This work analyses the common industry practice used to evaluate financial options written on with-profit policies issued by European insurance companies. In the last years regulators introduced, with the Solvency II directive, a market consistent valuation framework for determining the fair value of asset and liabilities of insurance funds. A relevant aspect is how to deal with the estimation of sovereign credit and liquidity risk, that are important components in the valuation of the majority of insurance funds, which are usually heavily invested in treasury bonds. The common practice is the adoption of the certainty equivalent approach (CEQ) for the risk neutral evaluation of insurance liabilities, which results in a deterministic risk adjustment of the securities cash flows. In this paper, we propose an arbitrage free stochastic model for interest rate, credit and liquidity risks, that takes into account the dependences between different government bond issuers. We test the impact of the common practice against our proposed model, via Monte Carlo simulations. We conclude that in the estimation of options whose pay-off is determined by statutory accounting rules, which is often the case for European traditional with-profit insurance products, the deterministic adjustment for risk of the securities cash flows is not appropriate, and that a more complete model such as the one described in this article is a viable and sensible alternative in the context of market consistent evaluations.

Quantitative Assessment of Common Practice Procedures in the Fair Evaluation of Embedded Options in Insurance Contracts

This work analyses the common practice used to evaluate financial options written on with-profit policies issued by European insurance companies. In the last years regulators introduced, with the Solvency II directive, a risk neutral valuation framework for determining the fair value of assets and liabilities of insurance funds. A relevant aspect is how to deal with the estimation of sovereign credit and liquidity risk, that are important components in the valuation of the majority insurance funds, which are usually heavily invested in treasury bonds. The common practice is the adoption of the certainty equivalent approach (CEQ) for the market consistent evaluation of insurance liabilities, which results in a deterministic risk adjustment of the securities cash flows. In this paper, we propose an arbitrage free stochastic model for interest rate, credit and liquidity risks, that takes into account the dependences between different government bond issuers. We test the impact of the common practice against our proposed model, via Monte Carlo simulations. We conclude that in the estimation of options whose pay-off is determined by statutory accounting rules, which is often the case for traditional with-profit insurance products, the deterministic adjustment for risk of the securities cash flows is not appropriate, and that a more complete model such as the one described in this article is a viable and sensible alternative in the context of market consistent evaluations.

Do not pay for a Danish interest guarantee. The law of the triple blow

AbstractWe have investigated the performance of pension schemes of with-profit policies containing a guaranteed minimum rate of return and we have found that the price of the guarantee measured in terms of lost returns is enormous. We use simple simulations rather than complex pricing methods to illustrate that the price of an interest guarantee is high in pension products that are currently commercialised in the market. We have found that the customer loses up to about 0.75% yearly in the rate of return when an interest guarantee is purchased, compared to the return of an equivalent saving strategy with the same risk at the level 95%. This can explain why such arrangements are not widely popular. Our approach can be used to inform clients, who are not experts in modern financial models, the impact of paying for an interest guarantee.

On the application of efficient hybrid heuristic algorithms – An insurance industry example

This paper proposes an optimization approach for generating an investment strategy for multi-period asset-liability management of long-term with-profit life insurance policies. Our approach uses models to simulate the processes insurance companies employ when determining multi-period investment strategies over a given planning horizon. The approach utilizes an enhanced heuristic algorithm to determine optimal multi-period investment strategies. Simulation models take into account asset numbers, objective functions, and asset allocation frequency. Strategy performance is evaluated by applying three single-period investment strategies to the simulation models. Computational results not only verify the efficiency and robustness of the algorithm, but also demonstrate the effectiveness of frequent asset reallocation, and dispute the suitability of traditional top-down investment strategies in maximizing investment returns of with-profit insurance policies.

생명보험회사의 배당 전략에 관한 연구 -영국 생명보험회사의 사례 및 실증분석을 중심으로-

The purpose of this paper is to analyse the advantages of with-profits and make a proposal for invigorating with-profits business. The data of life insurance companies in the U.K. is used and correlation and regression are employed. The implications are drawn from the analysis. The results and implications of this paper are summarized as follows. Firstly, the with-profits policies increase premium income. There is no positive relationship between with-profits policies and operating costs. The companies that are financially sound sell more with-profits policies than those not solvent. Secondly, with regard to implications for insurance companies, they can make full use of with-profits policies for marketing purpose and the main product in the product portfolio. Finally, with regard to implications for the policyholders, the with-profits policies are not expensive by comparison with the without-profits policies. The with-profits policies provide benefit to the policyholders on a solvency basis.

The U.K. With-Profits Life Insurance Industry: A Market Analysis

ABSTRACTThis paper reviews the market structure of the U.K. with-profits life insurance market and the potential effect on how life insurers operate. We consider the competitiveness of the market, quantifying the increase in the degree of concentration since 2000, and establishing that inherited estates may offer some protection from competition for incumbent firms. However, there is a significant degree of mobility in market positions of leading firms. Analysis of costs indicates some large differences between firms, with larger firms experiencing lower cost ratios, indicative of economies of scale. There are some marked differences in insurers' prices, the data showing that charges tend to be lower on unit-linked than on with-profits policies. The paper suggests that while there are potential concerns about how the market operates for consumers, the impact is limited by the dramatic reduction in new with-profits business.

Valuation and hedging of participating life-insurance policies under management discretion

The valuation and hedging of participating life insurance policies, also known as with-profits policies, is considered. Such policies can be seen as European path-dependent contingent claims whose underlying security is the investment portfolio of the insurance company that sold the policy. The fair valuation of these policies is studied under the assumption that the insurance company has the right to modify the investment strategy of the underlying portfolio at any time. Furthermore, it is assumed that the issuer of the policy does not setup a separate portfolio to hedge the risk associated with the policy. Instead, the issuer will use its discretion about the investment strategy of the underlying portfolio to hedge shortfall risks. In that sense, the insurer’s investment portfolio serves simultaneously as the underlying security and as the hedge portfolio. This means that the hedging problem can not be separated from the valuation problem. We investigate the relationship between risk-neutral valuation and hedging of these policies in complete and incomplete financial markets.

Constraints on discretion: Distributing surplus in with‐profits life insurance

When Equitable Life went to court in a case concerning the bonus rates it applied to pension policies with guaranteed annuity options, it emphasised that its rules gave it wide discretion in its bonus decisions, an argument that was unsuccessful. This paper considers the constraints on the discretion available to life insurers in the way they determine bonuses on with‐profits policies. It reviews four previous court cases concerning withprofits policies: in one of these, the insurer lost. The Financial Services Authority has now taken on board the need for life insurers to describe their bonus practices far more fully. That will help lead to a more precisely defined contract between policyholders and insurers. It is also proposing new rules, which should reduce the potential for discretion to be abused. The paper also considers the actuarial profession, whose members have the responsibility of making recommendations to life insurers about bonuses. It suggests there may be benefit if the profession can go beyond the limited guidance on bonuses it has issued, to develop and publish best practice in the bonus declaration process.

The bonus-crediting mechanism of Danish pension and life insurance companies: an empirical analysis

This paper develops and estimates a model for the bonus-crediting mechanism in relation to with-profits policies issued by Danish life insurance and pension companies. The market for pension and life insurance savings contracts is generally highly opaque, but our proposed model explains a significant part of the variation in actual bonus distribution by Danish market participants. The main determinant of bonus policy is a measure of the degree of solvency which we construct from a unique data set that contains information compiled from several public as well as non-public sources. The data set spans the ten-year period from 1991 to 2000 and the model is estimated by way of maximum likelihood.

Guaranteed Annuity Options: Five Issues for Resolution

ABSTRACTThis paper considers five issues arising from guaranteed annuity options in pension policies issued by United Kingdom life assurance companies. These are the investment strategies for such options, the implications for bonuses on with-profits policies, the measurement of the solvency position and preparation of accounts of the companies concerned, and the policy debate on compulsory annuitisation. In particular, the paper highlights the impact of improving mortality on the value of options, comments on the House of Lords judgment in the Equitable Life case, and suggests additional disclosures in the accounts of life assurance companies.

Address by the President. Developing a proactive role

ABSTRACTThe Presidential Address visits some of the current issues affecting the actuarial profession and expresses some personal views of the President. Subjects covered include with-profits policies, life assurance withdrawals and disclosure, Europe, education (concerning both actuarial examinations and continuing professional education), general insurance and pensions. The Address demonstrates the need for proactivity in a world which is continually changing, which is the theme of the 2-year presidency.

Calculation of Premiums and Asset Shares with Allowance for Changes in Capital Values

SynopsisThe paper sets out to develop a method for measuring the effect which changes in capital value of securities may have on premiums and asset shares. It is shown that any such method will involve an assumption as to allocation of assets to particular sections of business, and to particular policies within those sections of business. Different approaches to the allocation of assets are discussed as a preliminary to the development of formulae which take account of changes in capital value of both fixed interest stocks and equities.Examples are given to illustrate the accumulation of asset shares in funds of different composition under varying investment conditions, on the basis of a “unit trust” approach to the allocation of assets.The paper concludes with some comments on surplus distribution under individual and group with-profits policies.

A Consistent System of Investment and Bonus Distribution for a Life Office

The object of this paper is to continue the discussion on the valuation and bonus problems of a life office that was recommenced in the recent papers by A. T. Haynes and R. J. Kirton (T.F.A. xxi, 141) and by F. M. Redington (J.I.A. lxxviii, 286). Both of these papers were concerned, inter alia, with the principle of matching assets to liabilities or, in Redington's graphic phrase, of immunizing the life fund against the effects of a change in the general level of interest rates. Immunization of a life fund containing with-profits policies was shown by Redington to have far-reaching implications, and it was clear from the discussion on his paper that different opinions were held about the exact character of the immunization that might be most appropriate. For a non-profits fund total immunization may or may not be a suitable ideal with which to compare the practical position, and this would depend, in particular, upon the relative size of the capital and other free resources available and upon the level of the surrender and paid-up-policy options granted. But it is the purpose of this paper to argue that, for a with-profits fund, far from being a suitable ideal to be either aimed at or departed from, total immunization (including absolute matching) represents a dividing line between a zone of rational departure from another and more natural ideal and a zone in which a change in the level of interest rates would produce indefensible results.

The Force of Adverse Selection among Entrants at the Extremes of Life.

A paper read before the Life Insurance Medical Directors' Association of America in which Dr Fisk re-examines, with the help of additional information, some conclusions expressed by Mr T. B. Macaulay in 1893, and comes to the conclusion that there is little adverse selection under 25, but that the group over 60 is hypersensitive. It seems to us that this last conclusion is a natural consequence of an increasing value of the rate of mortality combined with paucity of data, and we also do not feel satisfied that Dr Fisk has done well in choosing the 0 (or with-profit policies) in preference to the ONv (or without-profit policies) for his investigation as regards English experience. W. P. E.

On Bonuses on Endowment-Assurance Policies

In a paper which I read before the Institute of Actuaries in April 1887 (J.I.A., xxvi, 357) I gave some tables which seemed to me likely to be of use, in the case of certain life offices, for the purpose of forming estimates of the amounts of bonuses arising on ordinary whole-term with-profit policies. The offices contemplated were mutual societies, making their periodical valuations every five years by the HM Table, at 3 per-cent interest. Life offices differ so much in regard to rates of premium charged and rate and incidence of expenses, and also in regard to the rate of interest earned by their funds, that it appeared to me it would be desirable to construct tables in such a form that the bonuses, which would fit the circumstances of any particular office, might, without difficulty, be calculated from them, rather than to calculate bonuses for a hypothetical office. An illustration was given, it is true, but this was subsidiary to the main purpose of the paper, and was furnished with the object of showing how the tables might be applied.