A Large-Scale Optimization Model for Replicating Portfolios in the Life Insurance Industry

Maximilian Adelmann (), Lucio Fernandez-Arjona (), Janos Mayer () and Karl Schmedders
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Maximilian Adelmann: Department of Business Administration, University of Zurich, 8032 Zurich, Switzerland
Lucio Fernandez-Arjona: Department of Business Administration, University of Zurich, 8032 Zurich, Switzerland
Janos Mayer: Department of Business Administration, University of Zurich, 8032 Zurich, Switzerland

Operations Research, 2021, vol. 69, issue 4, 1134-1157

Abstract: Replicating portfolios have emerged as an important tool in the life insurance industry, used for the valuation of companies’ liabilities. This paper describes the replicating portfolio (RP) model used to approximate life insurance liabilities in a large global insurance company. We describe the challenges presented by the latest solvency regimes in Europe and how the RP model enables this company to comply with the Swiss Solvency Test. The model minimizes the L 1 error between the discounted life insurance liability cash flows and the discounted RP cash flows over a multiperiod time horizon for a broad range of different future economic scenarios. A numerical application of the RP model to empirical data sets demonstrates that the model delivers RPs that match the liabilities and perform well for economic capital calculations.

Keywords: finance: portfolio; financial institutions: insurance; programming: linear; OR Practice; insurance regulation; liability cash flows; linear programming; out-of-sample tests; replicating portfolios; Solvency II (search for similar items in EconPapers)
Date: 2021
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http://dx.doi.org/10.1287/opre.2020.2098 (application/pdf)

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Working Paper: A Large-Scale Optimization Model for Replicating Portfolios in the Life Insurance Industry (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:inm:oropre:v:69:y:2021:i:4:p:1134-1157

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