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Deflation Risk and Implications for Life Insurers

Jean-François Bégin ()
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Jean-François Bégin: Department of Statistics and Actuarial Science, Simon Fraser University, 8888 University Drive, Burnaby, BC V5A 1S6, Canada

Risks, 2016, vol. 4, issue 4, 1-36

Abstract: Life insurers are exposed to deflation risk: falling prices could lead to insufficient investment returns, and inflation-indexed protections could make insurers vulnerable to deflation. In this spirit, this paper proposes a market-based methodology for measuring deflation risk based on a discrete framework: the latter accounts for the real interest rate, the inflation index level, its conditional variance, and the expected inflation rate. US inflation data are then used to estimate the model and show the importance of deflation risk. Specifically, the distribution of a fictitious life insurer’s future payments is investigated. We find that the proposed inflation model yields higher risk measures than the ones obtained using competing models, stressing the need for dynamic and market-consistent inflation modelling in the life insurance industry.

Keywords: deflation risk; life insurance; risk management; unscented Kalman filter; inflation caps and floors (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 M2 M4 K2 (search for similar items in EconPapers)
Date: 2016
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Handle: RePEc:gam:jrisks:v:4:y:2016:i:4:p:46-:d:84409