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Solvency Capital, Pricing and Capitalization Strategies of Life Annuity Providers

Author

Listed:
  • Maathumai Nirmalendran

    () (Finity Consulting)

  • Michael Sherris

    () (School of Risk and Actuarial Studies and ARC Centre of Excellence in Population Ageing Research, Australian School of Business, University of New South Wales)

  • Katja Hanewald

    () (School of Risk and Actuarial Studies and ARC Centre of Excellence in Population Ageing Research, Australian School of Business, University of New South Wales)

Abstract

This paper provides a detailed quantitative assessment of the impact of solvency capital requirements on product pricing and shareholder value for a life insurer. A multi-period firm value maximization model for a life annuity provider, allowing for stochastic mortality and asset returns, imperfectly elastic product demand, as well as frictional costs, is used to derive optimal capital and pricing strategies for a range of solvency levels reflecting differences in regulatory regimes. The model is calibrated using realistic assumptions and the sensitivity of results assessed. The results show that value-maximizing insurers should target higher solvency levels than the Solvency II regulatory 99.5% under assumptions of reasonable levels of policyholder's aversion to insolvency risk. Even in the case of less restrictive solvency regulation, policyholder price elasticity and solvency preferences are shown to be important factors for a life insurer's profit maximizing strategy.

Suggested Citation

  • Maathumai Nirmalendran & Michael Sherris & Katja Hanewald, 2012. "Solvency Capital, Pricing and Capitalization Strategies of Life Annuity Providers," Working Papers 201213, ARC Centre of Excellence in Population Ageing Research (CEPAR), Australian School of Business, University of New South Wales.
  • Handle: RePEc:asb:wpaper:201213
    as

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    File URL: http://cepar.edu.au/media/80542/wp_14_solvency_capital__pricing_and_capitalization.pdf
    File Function: First version, 2012
    Download Restriction: no

    References listed on IDEAS

    as
    1. Yow, Shaun & Sherris, Michael, 2008. "Enterprise Risk Management, Insurer Value Maximisation, and Market Frictions," ASTIN Bulletin: The Journal of the International Actuarial Association, Cambridge University Press, vol. 38(01), pages 293-339, May.
    2. Sachi Purcal & John Piggott, 2008. "Explaining Low Annuity Demand: An Optimal Portfolio Application to Japan," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 75(2), pages 493-516.
    3. Jeffrey R. Brown & Peter R. Orszag, 2006. "The Political Economy of Government-Issued Longevity Bonds," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 73(4), pages 611-631.
    4. Zanjani, George, 2002. "Pricing and capital allocation in catastrophe insurance," Journal of Financial Economics, Elsevier, vol. 65(2), pages 283-305, August.
    5. Helmut Gr√ľndl & Thomas Post & Roman N. Schulze, 2006. "To Hedge or Not to Hedge: Managing Demographic Risk in Life Insurance Companies," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 73(1), pages 19-41.
    6. Wills, Samuel & Sherris, Michael, 2010. "Securitization, structuring and pricing of longevity risk," Insurance: Mathematics and Economics, Elsevier, vol. 46(1), pages 173-185, February.
    7. Ray Rees & Hugh Gravelle & Achim Wambach, 1999. "Regulation of Insurance Markets," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 24(1), pages 55-68, June.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Life annuity; insurance regulation; solvency; longevity risk;

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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