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

Olivier Le Courtois (), Mohamed Majri and Li Shen
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Olivier Le Courtois: EM - EMLyon Business School
Li Shen: EM - EMLyon Business School

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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: overall solvency needs; expected utility theory; cumulative prospect theory; ORSA; market-consistent; SAHARA-CPT; SAHARA; own funds; Fair value; best estimate of liabilities (search for similar items in EconPapers)
Date: 2021-01-01
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Published in APJRI, Asia-Pacific Journal of Risk and Insurance, 2021, 15 (1), pp.47 - 79. ⟨10.1515/apjri-2019-0047⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-05606685

DOI: 10.1515/apjri-2019-0047

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