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Longevity risk, cost of capital and hedging for life insurers under Solvency II

Listed author(s):
  • Meyricke, Ramona
  • Sherris, Michael
Registered author(s):

    The cost of capital is an important factor determining the premiums charged by life insurers issuing life annuities. This capital cost can be reduced by hedging longevity risk with longevity swaps, a form of reinsurance. We assess the costs of longevity risk management using indemnity based longevity swaps compared to costs of holding capital under Solvency II. We show that, using a reasonable market price of longevity risk, the market cost of hedging longevity risk for earlier ages is lower than the cost of capital required under Solvency II. Longevity swaps covering higher ages, around 90 and above, have higher market hedging costs than the saving in the cost of regulatory capital. The Solvency II capital regulations for longevity risk generates an incentive for life insurers to hold longevity tail risk on their own balance sheets, rather than transferring this to the reinsurance or the capital markets. This aspect of the Solvency II capital requirements is not well understood and raises important policy issues for the management of longevity risk.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0167668714000146
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    Article provided by Elsevier in its journal Insurance: Mathematics and Economics.

    Volume (Year): 55 (2014)
    Issue (Month): C ()
    Pages: 147-155

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    Handle: RePEc:eee:insuma:v:55:y:2014:i:c:p:147-155
    DOI: 10.1016/j.insmatheco.2014.01.010
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505554

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    1. Matthew Elderfield, 2009. "Solvency II: Setting the Pace for Regulatory Change," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 34(1), pages 35-41, January.
    2. Enrico Biffis & David Blake & Lorenzo Pitotti & Ariel Sun, 2016. "The Cost of Counterparty Risk and Collateralization in Longevity Swaps," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 83(2), pages 387-419, June.
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    8. Ragnar Norberg, 2013. "Optimal hedging of demographic risk in life insurance," Finance and Stochastics, Springer, vol. 17(1), pages 197-222, January.
    9. Blake, David & Brockett, Patrick & Cox, Samuel & MacMinn, Richard, 2011. "Longevity risk and capital markets: The 2009-2010 update," MPRA Paper 28868, University Library of Munich, Germany.
    10. Andrew J. G. Cairns & David Blake & Kevin Dowd, 2006. "A Two-Factor Model for Stochastic Mortality with Parameter Uncertainty: Theory and Calibration," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 73(4), pages 687-718.
    11. Wills, Samuel & Sherris, Michael, 2010. "Securitization, structuring and pricing of longevity risk," Insurance: Mathematics and Economics, Elsevier, vol. 46(1), pages 173-185, February.
    12. Blake, David & Biffs, Enrico, 2012. "Keeping Some Skin in the Game: How to Start a Capital Market in Longevity Risk Transfers," MPRA Paper 44680, University Library of Munich, Germany.
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