Measuring and Managing the Economic Risks and Costs of With-Profits Business

Abstract

The approaches to liability valuation, assessment of prudential capital and measurement of profit for life offices are undergoing radical change. A common thread runs through all of these proposed changes ö each change represents a move away from traditional actuarial approaches towards a more economically coherent, market-consistent approach. These changes should encourage a general improvement in the life industry's risk management processes. However, they will come at a cost. The measurement of the economic risks generated by the complex guarantees written by life offices is far more difficult than applying the latest resilience test equity fall. This will require a step change in the sophistication of life offices' risk and capital measurement and management know-how. The measurement of value, risk and capital will soon demand the application of`stochastic' modelling tools. In this paper, we explore some of the issues raised by the application of these approaches to the valuation and risk management of with-profits business.

After VaR: The Theory, Estimation, and Insurance Applications of Quantile‐Based Risk Measures

“…Mortality modeling (Olivieri, 2001; Czernicki, Harewood, and Taht, 2003; Cairns, Blake, and Dowd, 2005; Dowd et al, 2005). Reserving and capital (Li and Tsai, 2000; Hürlimann, 2001; Turnbull, 2002; Czernicki, Harewood, and Taht, 2003; Hibbert and Turnbull, 2003; Watson Wyatt, 2003, 2004; Moody's, 2004). Various miscellaneous insurance applications, such as modeling asset‐liability management (Jagger and Mehta, 1997; Swiss Re, 2000; Exley, Mehta, and Smith, 2000; Babbel, 2001), embedded options (Jørgensen, 2001), with‐profit guarantees (Hibbert and Turnbull, 2003), the impact of policyholder behavior on insurance company positions (Altschull and Robbins, 2003) and insurance company defaults (Moody's, 2004; Ekström, 2005).…”

“…Reserving and capital (Li and Tsai, 2000; Hürlimann, 2001; Turnbull, 2002; Czernicki, Harewood, and Taht, 2003; Hibbert and Turnbull, 2003; Watson Wyatt, 2003, 2004; Moody's, 2004).…”

“…Various miscellaneous insurance applications, such as modeling asset‐liability management (Jagger and Mehta, 1997; Swiss Re, 2000; Exley, Mehta, and Smith, 2000; Babbel, 2001), embedded options (Jørgensen, 2001), with‐profit guarantees (Hibbert and Turnbull, 2003), the impact of policyholder behavior on insurance company positions (Altschull and Robbins, 2003) and insurance company defaults (Moody's, 2004; Ekström, 2005).…”

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

“…Since the insurer has control about the with-profits fund any change in the composition of the fund will result in a change of the value of the with-profits insurance contract. Hibbert and Turnbull (2003) where the first to address this issue. They consider an insurance company in which the management have limited discretion in choosing the assets by applying a fixed rule to increase or decrease the equity exposer of the with-profits fund depending on the value of the insurer's assets and the maturity guarantees already declared.…”

The effect of management discretion on hedging and fair valuation of participating policies with maturity guarantees

“…However, in these papers, in contrast to our own, the hedging strategy does not ensure that bonuses can continue to be declared in the future. Hibbert and Turnbull (2003) describes how to calculate a fair value of a with-profits policy where the management have limited discretion in choosing the assets. They assume that the management follow a fixed rule such that they will reduce the equity exposure of the reference portfolio if the value of the guarantees rises too near to the value of the assets.…”