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Utility-Consistent Valuation Schemes for the Own Risk and Solvency Assessment of Life Insurance Companies

Author

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  • Le Courtois Olivier
  • Shen Li

    (Emlyon Business School, Address: 23, Avenue Guy de Collongue, 69134, Ecully Cedex, France)

  • Majri Mohamed

    (Groupe SMA, Address: 8 Rue Louis Armand, 75015, Paris, France)

Abstract

In this paper, we construct new valuation schemes for the liabilities and economic capital of insurance companies. Specifically, we first build a ‘SAHARA’ valuation framework based on Symmetric Asymptotic Hyperbolic Absolute Risk Aversion utility functions. Then, we construct a ‘SAHARA-CPT’ framework that incorporates the previous utility function as a value function and that is based on Cumulative Prospect Theory. The process used for assessing a life insurance company’s own funds consists in replacing the market-consistent parametrization with a utility-consistent parametrization that accounts for the risk aversion of the market and the long-term duration of the company’s commitments. Our illustrations show that this approach leads to a lower value of the Own Risk and Solvency Assessment and to a lower volatility of own funds. The framework that is based on cumulative prospect theory has the advantage over the expected utility theory framework that it considers a precautionary overweighting of extreme events, as a tradeoff for additional model complexity.

Suggested Citation

  • Le Courtois Olivier & Shen Li & Majri Mohamed, 2021. "Utility-Consistent Valuation Schemes for the Own Risk and Solvency Assessment of Life Insurance Companies," Asia-Pacific Journal of Risk and Insurance, De Gruyter, vol. 15(1), pages 1-33, January.
    • Handle: RePEc:bpj:apjrin:v:15:y:2021:i:1:p:33:n:4
    DOI: 10.1515/apjri-2019-0047
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    References listed on IDEAS

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    1. Jérémy Allali & Olivier Le Courtois & Mohamed Majri, 2018. "Credit risk and solvency capital requirements," Post-Print hal-02312247, HAL.
    2. Daniel Cavagnaro & Mark Pitt & Richard Gonzalez & Jay Myung, 2013. "Discriminating among probability weighting functions using adaptive design optimization," Journal of Risk and Uncertainty, Springer, vol. 47(3), pages 255-289, December.
    3. Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    4. Barberis, Nicholas & Thaler, Richard, 2003. "A survey of behavioral finance," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 18, pages 1053-1128, Elsevier.
    5. Floryszczak, Anthony & Le Courtois, Olivier & Majri, Mohamed, 2016. "Inside the Solvency 2 Black Box: Net Asset Values and Solvency Capital Requirements with a least-squares Monte-Carlo approach," Insurance: Mathematics and Economics, Elsevier, vol. 71(C), pages 15-26.
    6. Anthony Floryszczak & Olivier Le Courtois & Mohamed Majri, 2016. "Inside the Solvency 2 Black Box : Net asset values and solvency capital requirements with a least-squares Monte-Carlo approach," Post-Print hal-02313445, HAL.
    7. Changki Kim, 2005. "Modeling Surrender and Lapse Rates With Economic Variables," North American Actuarial Journal, Taylor & Francis Journals, vol. 9(4), pages 56-70.
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    Cited by:

    1. Olivier Le Courtois, 2022. "On the Diversification of Fixed Income Assets," Risks, MDPI, vol. 10(2), pages 1-21, February.

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