Optimal Asset Allocation in Life Insurance: The Impact of Regulation
ASTIN Bulletin, Vol. 46, No. 3 (2016), pp. 605-626
28 Pages Posted: 13 Jan 2015 Last revised: 26 Sep 2016
Date Written: January 12, 2015
In a typical equity-linked life insurance contract, the insurance company is entitled to a share of return surpluses as compensation for the return guarantee granted to the policyholders. The set of possible contract terms might, however, be restricted by a regulatory default constraint - a fact that can force the two parties to initiate sub-optimal insurance contracts. We show that this effect can be mitigated if regulatory policy is more flexible. We suggest that the regulator implement a traffic light system where companies are forced to reduce the riskiness of their asset allocation in distress. In a utility-based framework, we show that the introduction of such a system can increase the benefits of the policyholder without deteriorating the benefits of the insurance company. At the same time, default probabilities (and thus solvency capital requirements) can be reduced.
Keywords: regulation, life insurance, credit risk, barrier options, utility maximization, contract design
JEL Classification: G11, G23
Suggested Citation: Suggested Citation