Challenges in the Life Insurance Industry with Respect to Pricing and Risk Measurement

The Swiss life insurance industry plays a fundamental role in the Swiss economy. In 2005, Swiss private life insurers reported a premium volume of 30 billion CHF, thereby managing a capital amount of 120 billion CHF. In recent years, however, several developments in the life insurance industry have led to an increasing interest in valuation and risk measurement of life insurance liabilities, both in the academic world and for practitioners. Among these developments, three major trends can be highlighted that also will have an impact on the life insurance industry in Switzerland.

First, concern about implicit options intensified when the British life insurer Equitable Life had to close to new business in December 2000 due to the neglected pricing of the time value of guaranteed annuity rates. This and other incidents resulted in an increased awareness of the importance of implicit options in life insurance contracts, particularly concerning pricing and adequate risk management. The Swiss insurance industry is especially interested in a market-consistent valuation of liabilities, partly as the result of the ongoing regulatory process and the initiation of the Swiss Solvency Test in 2006. Further, the life settlement market has shown tremendous growth during the last 15 years and still exhibits substantial market potential. However, the benefits and detriments of a secondary market for life insurance for policyholders and insurers are still controversial in the literature. It may thus have a tremendous impact on primary insurers' portfolios due to a possibly larger number of higher-than-average risks (depending on the type of target policy of the secondary market) combined with an altered exercise behavior with respect to implicit options. Finally, there has been a trend toward consolidation in the financial sector of many countries. Financial groups offer benefits in terms of diversification, but they also introduce new sources of risk and risk concentrations. In this context, enterprise risk management and its practicable implementation have become increasingly important in maintaining the strength of insurance groups.

An analysis of these developments will be of high interest, especially for Switzerland due to the importance of the Swiss life insurance industry to the Swiss economy and society. In our research project, we intend to contribute to the analysis of these recent developments by concentrating on central aspects concerning fair valuation, risk assessment, and risk management of life insurance liabilities that have not been analyzed to date. Our goal is to provide valuable information and insight for insurers, policyholders, and regulators.