Stochastic Mortality, Macroeconomic Risks, and Life Insurer Solvency

Abstract

Motivated by a recent demographic study establishing a link between macroeconomic fluctuations and the mortality index kt in the Lee-Carter model, we develop a dynamic asset-liability model to assess the impact of macroeconomic fluctuations on the solvency of a life insurance company. Liabilities in this stochastic simulation framework are driven by a GDP-linked variant of the Lee-Carter mortality model. Furthermore, interest rates and stock prices react to changes in GDP, which itself is modelled as a stochastic process. Our simulation results show that insolvency probabilities are significantly higher when the reaction of mortality rates to changes in GDP is incorporated.

Keywords: Life insurance, asset-liability management, stochastic mortality, Lee-Carter model, business cycle

JEL Classification: G22, G23, G28, G32, E32, J11