Utility-Consistent Valuation Schemes for the Own Risk and Solvency Assessment of Life Insurance Companies

Le Courtois Olivier (), Majri Mohamed and Shen Li
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Le Courtois Olivier: Emlyon Business School, Address: 23, Avenue Guy de Collongue, 69134, Ecully Cedex, France
Majri Mohamed: Groupe SMA, Address: 8 Rue Louis Armand, 75015, Paris, France
Shen Li: Emlyon Business School, Address: 23, Avenue Guy de Collongue, 69134, Ecully Cedex, France

Asia-Pacific Journal of Risk and Insurance, 2021, vol. 15, issue 1, 47-79

Abstract: In this paper, we construct new valuation schemes for the liabilities and economic capital of insurance companies. Specifically, we first build a ‘SAHARA’ valuation framework based on Symmetric Asymptotic Hyperbolic Absolute Risk Aversion utility functions. Then, we construct a ‘SAHARA-CPT’ framework that incorporates the previous utility function as a value function and that is based on Cumulative Prospect Theory. The process used for assessing a life insurance company’s own funds consists in replacing the market-consistent parametrization with a utility-consistent parametrization that accounts for the risk aversion of the market and the long-term duration of the company’s commitments. Our illustrations show that this approach leads to a lower value of the Own Risk and Solvency Assessment and to a lower volatility of own funds. The framework that is based on cumulative prospect theory has the advantage over the expected utility theory framework that it considers a precautionary overweighting of extreme events, as a tradeoff for additional model complexity.

Keywords: expected utility theory; cumulative prospect theory; ORSA; market-consistent; fair value; best estimate of liabilities; overall solvency needs; own funds; SAHARA; SAHARA-CPT (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (1)

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DOI: 10.1515/apjri-2019-0047

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