Aggregate lapsation risk

Ralph S.J. Koijen, Hae Kang Lee and Stijn Van Nieuwerburgh

Journal of Financial Economics, 2024, vol. 155, issue C

Abstract: We study aggregate lapsation risk in the life insurance sector. We construct two lapsation risk factors that explain a large fraction of the common variation in lapse rates of the 30 largest life insurance companies. The first is a cyclical factor that is positively correlated with credit spreads and unemployment, while the second factor is a trend factor that correlates with the level of interest rates. Using a novel policy-level database from a large life insurer, we examine the heterogeneity in risk factor exposures based on policy and policyholder characteristics. Young policyholders with higher health risk in low-income areas are more likely to lapse their policies during economic downturns. We explore the implications for hedging and valuation of life insurance contracts. Ignoring aggregate lapsation risk results in mispricing of life insurance policies. The calibrated model points to overpricing on average. In the cross-section, young, low-income, and high-health risk households face higher effective mark-ups than the old, high-income, and healthy.

Keywords: Lapsation; Insurance; Business cycles; Hedging (search for similar items in EconPapers)
JEL-codes: E32 E44 G12 G22 G52 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Aggregate Lapsation Risk (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:155:y:2024:i:c:s0304405x24000424

DOI: 10.1016/j.jfineco.2024.103819

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