Hato Schmeiser

The Solvency Ii Process: Overview and Critical Analysis

As early as the 1970s, European Union (EU) member countries implemented rules to coordinate insurance markets and regulation. However, with the more recent movement toward a general single EU market, financial services regulation has taken on new meaning and priority. Solvency I regulations went into effect for member nations by January 2004. The creation of risk-based capital standards, the main focus of Solvency II, now appears likely sometime after 2007. The purpose of the discussion presented here is to outline the specifics of Solvency II as they currently stand and provide input to evaluation process that, ultimately, will determine the exact form of capital regulation. Our analysis leads us to conclude that caution is warranted.

Pricing Double-Trigger Reinsurance Contracts: Financial Versus Actuarial Approach

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Creating Customer Value in Participating Life Insurance

The value of a life insurance contract may differ depending on whether it is looked at from the customers point of view or that of the insurance company. We assume that the insurer is able to replicate the life insurance contracts cash flows via assets traded on the capital market and can hence apply risk‐neutral valuation techniques. The policyholder, on the other hand, will take risk preferences and diversification opportunities into account when placing a value on that same contract. Customer value is represented by policyholder willingness to pay and depends on the contract parameters, that is, the guaranteed interest rate and the annual and terminal surplus participation rate. The aim of this article is to analyze and compare these two perspectives. In particular, we identify contract parameter combinations that - while keeping the contract value fixed for the insurer - maximize customer value. In addition, we derive explicit expressions for a selection of specific cases. Our results suggest that a customer segmentation in this sense, that is, based on the different ways customers evaluate life insurance contracts and embedded investment guarantees while ensuring fair values, is worthwhile for insurance companies as doing so can result in substantial increases in policyholder willingness to pay.

Portfolio Optimization Under Solvency II: Implicit Constraints Imposed by the Market Risk Standard Formula

We consider the issue of optimizing an insurance companys asset allocation in the context of portfolio theory when the firm needs to adhere to the market risk capital requirements of Solvency II. The discussion starts with a brief review of the standard formula and the introduction of a parsimonious partial internal model. Subsequently, we estimate empirical risk-return profiles for the main asset classes held by insurers and run a quadratic optimization program to derive nondominated frontiers with budget, short-sale, and investment constraints. We then compute the respective capital charges under both solvency models and identify those efficient portfolio compositions that are permitted for an exogenously given amount of equity. Finally, we consider a systematically selected set of inefficient portfolios and check their admissibility, too. Our results document that the standard formula is unable to distinguish investments on the basis of risk-return profiles and does hence not produce economically sensible results. Therefore, the introduction of Solvency II in its current form might cause severe asset management biases in the European insurance sector.

The Impact of Introducing Insurance Guaranty Schemes on Pricing and Capital Structure

The introduction of an insurance guaranty scheme can have significant influence on the pricing and capital structures in a competitive market. The aim of this article is to study this effect on competitive equity–premium combinations while considering a framework with policyholders and equity holders where guaranty fund charges are volume‐based, as levied in existing schemes. Several settings with regard to the origin of the fund contributions are assessed and the immediate effects on the incentives of the policyholders and equity holders are analyzed through a one‐period contingent claim approach. One result is that introducing a guaranty scheme in a market with competitive conditions entails a shift of equity capital towards minimum solvency requirements. Hence, adverse incentives may arise with regard to the overall security level of the industry.

Under What Conditions is an Insurance Guaranty Fund Beneficial for Policyholders

In this article, we derive conditions in an imperfect market setting, under which the introduction of a self‐supporting insurance guaranty fund improves the position of the policyholders. When a guaranty fund is advantageous given homogeneous firms in the market, all policyholders benefit from it to the same extent, if they have the same underlying risk preferences and are charged identical premiums. In a more realistic heterogeneous setting, the introduction of an insurance guaranty fund is in general no longer beneficial for all policyholders in the same manner. Hence, systematic wealth transfers take place between the policyholders of different insurance companies. As a possible solution, and in order to counteract this effect, we introduce a framework for utility‐based fund charges.

Pricing and Performance of Mutual Funds: Lookback Versus Interest Rate Guarantees

The aim of this paper is to compare pricing and performance of mutual funds with two types of guarantees: a look back guarantee and an interest rate guarantee. In a simulation analysis of different portfolios based on stock, bond, real estate, and money market indices, we first calibrate guarantee costs to be the same for both investment guarantee funds. Second, their performance is contrasted, measured with the Sharpe ratio, Omega, and Sortino ratio, and a test with respect to first, second, and third order stochastic dominance is provided. We further investigate the impact of the underlying fund’s strategy, first looking at a conventional fund having a constant average rate of return and standard deviation over the contract term, and then at a Constant Proportion Portfolio Insurance managed fund. This analysis is intended to provide insights for investors with different risk-return preferences regarding the interaction of guarantee costs and the performance of different mutual funds with embedded investment guarantees.

Performance and Risks of Open‐End Life Settlement Funds

In this paper, we comprehensively analyze open-end funds dedicated to investing in U.S. senior life settlements. We begin by explaining their business model and the roles of institutions involved in the transactions of such funds. Next, we conduct the first empirical analysis of life settlement fund return distributions as well as a performance measurement, including a comparison to other asset classes. Since the funds contained in our dataset cover a large fraction of this relatively young segment of the capital markets, representative conclusions can be derived. Even though the empirical results suggest that life settlement funds offer attractive returns paired with low volatility and are virtually uncorrelated with other asset classes, we find latent risk factors such as liquidity, longevity and valuation risks. Since these risks did generally not materialize in the past and are hence largely not reflected by the historical data, they cannot be captured by classical performance measures. Thus, caution is advised in order not to overestimate the performance of this asset class.

The Impact of Private Equity on a Life Insurer's Capital Charges under Solvency II and the Swiss Solvency Test

In this article, we conduct an in‐depth analysis of the impact of private equity investments on the capital requirements faced by a representative life insurance company under Solvency II as well as the Swiss Solvency Test. Our discussion begins with an empirical performance measurement of the asset class over the period from 2001 to 2010, suggesting that limited partnership private equity funds may be suited for the purpose of portfolio enhancement. Subsequently, we review the market risk standard approaches set out by both regulatory regimes and outline a potential framework for an internal model. Based on an implementation of these solvency models, it is possible to demonstrate that private equity is overly penalized by the standard approaches. Hence, life insurers aiming to exploit the asset classs return potential may expect significantly lower capital charges when applying an economically sound internal model. Finally, we show that, from a regulatory capital perspective, it can even be less costly to increase the exposure to private rather than public equity.

On consumer preferences and the willingness to pay for term life insurance

We run a choice-based conjoint (CBC) analysis for term life insurance on a sample of 2017 German consumers using data from web-based experiments. Individual-level part-worth profiles are estimated by means of a hierarchical Bayes model. Drawing on the elicited preference structures, we then compute relative attribute importances and different willingness to pay measures. In addition, we present comprehensive simulation results for a realistic competitive setting that allows us to assess product switching as well as market expansion effects. On average, brand, critical illness cover, and underwriting procedure turn out to be the most important nonprice product attributes. Hence, if a policy comprises their favored specifications, customers accept substantial markups in the monthly premium. Furthermore, preferences vary considerably across the sample. While some individuals are prepared to pay relatively high monthly premiums, a large fraction exhibits no willingness to pay for term life insurance at all, presumably due to the absence of a need for mortality risk coverage. We also illustrate that utility-driven product optimization is well-suited to gain market shares, avoid competitive price pressure, and access additional profit potential. Finally, based on estimated demand sensitivities and a set of cost assumptions, it is shown that insurers require an in-depth understanding of preferences to identify the profit-maximizing price.