Further Results about Calibration of Longevity Risk for the Insurance Business

Abstract

In life insurance business, longevity risk, i.e. the risk that the insured population lives longer than the expected, represents the heart of the risk assessment, having significant impact in terms of solvency capital requirements (SCRs) needed to front the firm obligations. The credit crisis has shown that systemic risk as longevity risk is relevant and that for many insurers it is actually the dominant risk. With the adoption of the Solvency II directive, a new area for insurance in terms of solvency regulation has been opened up. The international guidelines prescribe a market consistent valuation of balance sheets, where the solvency capital requirements to be set aside are calculated according to a modular structure. By mapping the main risk affecting the insurance portfolio, the capital amount able to cover the liabilities corresponds to each measured risk. In Solvency II, the longevity risk is included into underwriting risk module. In particular, the rules propose that companies use a standard model for measuring the SCRs. Nevertheless, the legislation under consideration allows designing tailor-made internal models. As regards the longevity risk assessment, the regulatory standard model leads to noteworthy inconsistencies. In this paper, we propose a stochastic volatility model combined with a so-called coherent risk measure as the expected shortfall for measuring the SCRs according to more realistic assumptions on future evolution of longevity trend. Finally empirical evidence is provided.