Life Insurer Longevity Risk Management, Solvency and Shareholder Value

Abstract

This paper assesses the impact of longevity risk management on insurer shareholder value and solvency for an annual portfolio. The analysis uses a multi-period stochastic mortality model with both systematic and idiosyncratic longevity risk. We consider both survivor, or longevity, swaps that provide a full longevity risk hedge, and index-based survivor, or longevity, bonds that do not hedge idiosyncratic longevity risk. Shareholder value includes the impact of the costs of transferring longevity risk, policyholder demand elasticity, regulatory capital requirements, capital relief, and frictional costs including the insolvency put option, agency costs, and financial distress costs. Shareholder value is based on Economic Value (EV) and a Market-Consistent Embedded Value (MCEV) approach. Capital management is assessed based on a recapitalization and dividend strategy that maintains regulatory capital requirements, as defined under Solvency II. We demonstrate how longevity risk management strategies significantly reduce the volatility of shareholder value and frictional costs. Longevity risk management reduces the probability of insolvency, increases policyholder demand and hence increases shareholder value.

Keywords: longevity risk, capital management, solvency, reinsurance, securitization

JEL Classification: G22, G23, G32