Longevity Risk, Cost of Capital and Hedging for Life Insurers Under Solvency II

30 Pages Posted: 28 Sep 2013

See all articles by Ramona Meyricke

Ramona Meyricke

UNSW Australia Business School, School of Risk & Actuarial Studies; CEPAR, University of New South Wales; Swiss Re, Australia

Michael Sherris

UNSW Business School

Date Written: September 23, 2013

Abstract

The cost of capital is an important factor determining the premiums charged by life insurers issuing life annuities. Insurers will be able to offer more finely priced annuities if they can reduce this cost whilst maintaining solvency. This capital cost can be reduced by hedging longevity risk with longevity swaps, a form of reinsurance. We assess the costs of longevity risk management using longevity swaps compared to costs of holding capital under Solvency II. We show that, using a reasonable market price of longevity risk, the market cost of hedging longevity risk for earlier ages is lower than the cost of capital required under Solvency II. Longevity swaps covering higher ages, around 90 and above, have higher market hedging costs than the saving in the cost of regulatory capital. The Solvency II capital regulations for longevity risk generates an incentive for life insurers to hold longevity tail risk on their own balance sheets, rather than transfer this to the reinsurance or the capital markets. This aspect of the Solvency II capital requirements is not well understood and raises important policy issues for the management of longevity risk.

Keywords: capital management, solvency, longevity risk, reinsurance, securitization

JEL Classification: G22, G23, G32

Suggested Citation

Meyricke, Ramona and Sherris, Michael, Longevity Risk, Cost of Capital and Hedging for Life Insurers Under Solvency II (September 23, 2013). UNSW Australian School of Business Research Paper No. 2013ACTL18, Available at SSRN: https://ssrn.com/abstract=2331660 or http://dx.doi.org/10.2139/ssrn.2331660

Ramona Meyricke (Contact Author)

UNSW Australia Business School, School of Risk & Actuarial Studies ( email )

Room 2058 South Wing 2nd Floor
Quadrangle building, Kensington Campus
Sydney, NSW 2052
Australia

CEPAR, University of New South Wales ( email )

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Australian School of Business Building
Sydney, New South Wales NSW 2052
Australia

Swiss Re, Australia ( email )

363 George St
Sydney, NSW 2000
Australia

Michael Sherris

UNSW Business School ( email )

Sydney, NSW 2052
Australia

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