Surrender contagion in life insurance

Chunli Cheng, Christian Hilpert, Aidin Miri Lavasani and Mick Schaefer

European Journal of Operational Research, 2023, vol. 305, issue 3, 1465-1479

Abstract: Modern life insurance policies embed a surrender option that entitles policyholders to terminate their policy early for its cash value. Mass surrenders–spiking surrenders of life insurance policies within a short period–are widely documented prior to many life insurer failures, but their impacts on insurers are rarely quantified. This paper builds a model of mass surrenders in a heterogeneous pool consisting of a minority of financially guided policyholders who make rational surrender decisions and a majority of individual policyholders who are subject to herd. By revising the self-excitation in the Hawkes process to a contingent event-accumulation-excitation, we introduce a history-dependent surrender process for the individuals whose contagious behavior can be triggered contingent on past surrenders becoming salient. We then incorporate it into a life insurance pricing framework and study mass surrenders’ impacts on contract valuation and default risk of the insurer, allowing for its structural default under regulatory solvency intervention. Our numerical results show that while contagion aligns individual policyholders’ surrender behavior with the optimal surrender of financially guided ones, it jeopardizes their financial positions in favor of equity holders. Surprisingly, surrender contagion only mildly enlarges an insurer’s bankruptcy rate, which is not driven by strict solvency regulation. Despite its public perception of posing a significant risk to insurers as similar to a bank run, surrender contagion does not critically threaten insurers’ solvency: To prevent insurers’ bankruptcies, their investment riskiness and leverage pose more of a concern to regulators.

Keywords: Risk analysis; Contagious surrender risk; Insurance regulation; Default risk; Hawkes process (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:305:y:2023:i:3:p:1465-1479

DOI: 10.1016/j.ejor.2022.07.009

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