To Hedge or Not to Hedge: Managing Demographic Risk in Life Insurance Companies

Humboldt University Berlin: Department of Business and Economics: Discussion Papers in Business

31 Pages Posted: 26 May 2009

See all articles by Thomas Post

Thomas Post

Maastricht University - School of Business and Economics - Department of Finance; Netspar

Helmut Gründl

Goethe University Frankfurt - Department of Finance; International Center for Insurance Regulation

Roman Schulze

Humboldt University of Berlin

Multiple version iconThere are 2 versions of this paper

Date Written: September 27, 2005

Abstract

Demographic risk, i.e., the risk that life tables change in a nondeterministic way, is a serious threat to the financial stability of an insurance company having underwritten life insurance and annuity business. The inverse influence of changes in mortality laws on the market value of life insurance and annuity liabilities creates natural hedging opportunities. Within a realistically calibrated shareholder value maximization framework, we analyze the implications of demographic risk on the optimal risk management mix (equity capital, asset allocation, and product policy) for a limited liability insurance company operating in a market with insolvency-averse insurance buyers. Our results show that the utilization of natural hedging is optimal only if equity is scarce. Otherwise, hedging can even destroy shareholder value. A sensitivity analysis shows that a misspecification of demographic risk has severe consequences for both the insurer and the insured. This result highlights the importance of further research in the field of demographic risk.

Keywords: demographic risk, hedging, life insurance, risk management, shareholder value

JEL Classification: G22, G31, G32, J11

Suggested Citation

Post, Thomas and Gründl, Helmut and Schulze, Roman, To Hedge or Not to Hedge: Managing Demographic Risk in Life Insurance Companies (September 27, 2005). Humboldt University Berlin: Department of Business and Economics: Discussion Papers in Business. Available at SSRN: https://ssrn.com/abstract=731823 or http://dx.doi.org/10.2139/ssrn.731823

Thomas Post

Maastricht University - School of Business and Economics - Department of Finance ( email )

Tongersestraat 53
Maastricht, 6200 MD
Netherlands
+31 43 38 83899 (Phone)
+31 43 38 84875 (Fax)

HOME PAGE: http://www.thomas-post.com

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

HOME PAGE: http://www.netspar.nl

Helmut Gründl (Contact Author)

Goethe University Frankfurt - Department of Finance ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, Hessen 60323
Germany

HOME PAGE: http://https://www.wiwi.uni-frankfurt.de/en/departments/finance/home.html

International Center for Insurance Regulation ( email )

House of Finance
Campus Westend, Goethe University
Frankfurt am Main, D-60323
Germany

HOME PAGE: http://www.icir.de

Roman Schulze

Humboldt University of Berlin ( email )

Unter den Linden 6
Berlin, AK Berlin 10099
Germany

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