The objective of this paper is to contribute to a better understanding of the driving forces of a life insurance company. More specifically, the issues of the duration and convexity of insurance liabilities and equity are addressed. These issues deserve a careful rethinking given the recent trends that have affected the insurance landscape. A correct assessment of these risk measures is critical as they constitute the primary ingredients of any sound asset-liability management approach. In addition, the effort toward a more detailed and more accurate risk picture of life insurance operations enables one to debunk some pitfalls that are commonly encountered in the insurance industry.

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In this paper we develop a contingent claim model to evaluate the equity and liabilities of a life insurance company. The limited liability of shareholders is explicitly modelled. We focus on a specific type of life insurance policy–namely, the profit-sharing policy. In this policy, the policyholder is entitled to a guaranteed interest rate and a percentage of the company's yearly financial revenues. The implicit equilibrium interest rate and profit-sharing ratio are derived and analyzed. We finally discuss regulatory measures frequently encountered in the life insurance business such as rate ceilings, capital ratios, and asset restrictions. The Geneva Papers on Risk and Insurance Theory (1994) 19, 53–72. doi:10.1007/BF01112014

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