Consequences of the Reduction of Interest Rates on Insurance
22 Pages Posted: 19 Apr 2000
Date Written: May 22, 1999
Abstract
In this paper we try to assess the impact of various policy changes on the ability of the insurance industry to preserve or increase the shareholders' value. As a proxy of the sensitivity of the shareholders value, we measure the sensitivity of ROE (Return On Equities) to three main variables i.e.:
1. different asset allocation strategies (low and high risk investment of segregated funds); 2. different minimum guaranteed returns for policyholders (floor options); 3. cost cutting policy (fixed and distribution costs);
The ROE sensitivity is estimated through a Monte Carlo simulation where, given the actual market conditions, the segregated fund is invested in three total return market indices, and no foreign exchange risk. A 10-year single premium policy, with a reimbursement only at maturity is considered. We show that with a high minimum guaranteed return and the actual prevailing financial market conditions, aggressive investment policies (stocks in excess of 10-15% of total assets) are likely to destroy shareholders' value. Our results indicate that reduction of minimum guaranteed rates and cost cutting are imperative, and an appropriate combination of the two appears to be the best solution.
JEL Classification: C10, C41, D40, G22
Suggested Citation: Suggested Citation