In the following section, we describe the insurance company model. It is inspired by the model used by Bohnert and Gatzert (
2014) and uses parts of the modelling strategies proposed by Kochanski and Karnarski (
2011). Our contribution primarily lies in proposing algorithms for model inflows to the PPR and for the bonus distribution, two mechanisms not included in previous models but constituting the aforementioned interaction effect. The observed time periods will be
\(t \epsilon \{0,...,T\}, \quad T= 12\cdot n +1\), where
n is the contract duration of the policies sold by the insurer. For our standard contract duration of 30 years,
\(T=361\), giving one period for each month in the 30 years plus one for the initial values (
\(t=0\)) and one for the final values (
\(t=361\)). Let
\(Y:= \{t= 12\cdot i|i \epsilon \{1,...,n\} \} \subset \{0,\ldots ,T\}\) denote the set of end-of-year periods. This will come in handy since some variables change only at the end of a year. The balance sheet of the insurer is illustrated in Table
2.
Table 2
Economic balance sheet
\(A^{\mathrm{lt}}\) | \(\mathrm{PR}^{\mathrm{TDA}} \) |
\(A^{\mathrm{st}} \) | \(\mathrm{PR}^{\mathrm{DHP}} \) |
\(\mathrm{GF}^{A}\) | \(\mathrm{GF}^{L} \) |
\(\mathrm{EF}^{A} \) | \(\mathrm{EF}^{L} \) |
| \(\mathrm{PPR} \) |
| \(\mathrm{EC}^{\mathrm{lt}}\) |
| \(\mathrm{EC}^{\mathrm{st}}\) |
On the asset side of the balance sheet, we have assets that are long-term investments
\(A^{\mathrm{lt}}\) and others that are invested short term
\(A^{\mathrm{st}}\). We further see the items
\(\mathrm{GF}^{A}\) and
\(\mathrm{EF}^{A}\) standing for investment in the DHP’s guarantee and equity funds. Since the policyholders bear the risk for the investment in the GF and EF, they are always equivalent to their counterparts on the liability side
\(\mathrm{GF}^L\) and
\(\mathrm{EF}^L\). On the liability side, we find the insurer’s policy reserves PR, split between those “belonging” to the two subgroups of policyholders. The provisions for premium refunds PPR and the equity capital EC complete the insurer’s liabilities. The EC is artificially split into a part that is invested in long-term assets (
\(\mathrm{EC}^{\mathrm{lt}}\)) and a liquidity cushion (
\(\mathrm{EC}^{\mathrm{st}}\)). Table
3 enumerates the variables used in the model.
\(A^{\mathrm{lt}}_{t}\) | Assets long term |
\(A^{\mathrm{st}}_{t}\) | Assets short term |
\(\mathrm{PR}^{\mathrm{TDA}}_{t}\) | Policy reserves TDA |
\(\mathrm{PR}^{\mathrm{DHP}}_{t}\) | Policy reserves DHP |
\(\mathrm{GF}_{t}\) | Guarantee fund |
\(\mathrm{EF}_{t}\) | Equity fund |
\(G_{t}\) | Risk free guarantee amount DHP (see Kochanski and Karnarski 2011) |
\(\mathrm{PPR}_{t}\) | Provisions for premium refunds |
\(\mathrm{EC}^{\mathrm{lt}}\) | Equity capital invested long term |
\(\mathrm{EC}^{\mathrm{st}}_{t}\) | Equity capital invested short term (liquidity cushion) |
\(\mathrm{LSP}_{t}\) | Lump-sum payment TDA at contract termination |
\(\mathrm{NIS}_{t}\) | Net interest surplus |
\(\mathrm{RR}^{\mathrm{TDA}}_{t}\) | Risk result TDA |
\(\mathrm{AV}_{t}\) | Account value of a single DHP contract |
\(\mathrm{Bonus}^{\mathrm{TDA}}_{t}\) | Bonus payment allocated to TDA policyholders |
\(\mathrm{Bonus}^{\mathrm{DHP}}_{t}\) | Bonus payment allocated to DHP policyholders |
\(\mathrm{Inflows}^{\mathrm{PPR}}_{t}\) | Inflows to the provisions for premium refunds |
\(L^{\mathrm{TDA}}_{t}\) | Number of living TDA policyholders |
\({\mathcal {E}}_{t-1}\left[ L^{\mathrm{TDA}}_{t}\right] \) | Expected number of living TDA policyholders |
\(L^{\mathrm{DHP}}_{t}\) | Number of living DHP policyholders |
The number of living policyholders for
\(j \epsilon \{\mathrm{TDA},\mathrm{DHP}\}\) is assumed to evolve in the following way:
$$\begin{aligned} L^{j}_{t} = \left\lfloor L^{j}_{t-1} \cdot \left( l^{\mathrm{SOCB}}_{x+\lfloor t/12 \rfloor }\right) \left( l^{\mathrm{SOCB}}_{x+\lfloor (t-1)/12 \rfloor }\right) ^{-1} \right\rfloor \end{aligned}$$
(3)
where
\(l^{\mathrm{SOCB}}_{m}\) are second-order calculation bases for the number of
m year old men taken from the mortality table
DAV2004R (without the security-margin imposed by law).
6 We assume that each policyholder buys only one contract. The number of expected living (i.e. the number used by the insurer in period
\(t-1\) to calculate their policy reserves in period
t) is assumed to evolve as follows:
$$\begin{aligned} {\mathcal {E}}_{t-1} \left[ L^{\mathrm{TDA}}_{t} \right] = L^{\mathrm{TDA}}_{t-1} \cdot \left( l^{\mathrm{FOCB}}_{x+\lfloor t/12 \rfloor }\right) \left( l^{\mathrm{FOCB}}_{x+\lfloor (t-1)/12 \rfloor }\right) ^{-1} \end{aligned}$$
(4)
where
\(l^{\mathrm{FOCB}}_{m}\) are first-order calculation bases for the number of
m-year-old men taken from the mortality table
DAV2004R (with security margin). Note that we do not calculate this variable for DHP since we assume this product to pay a death benefit.
7 A measure closely connected to the calculation bases and used at later points is the so-called number of discounted living at age m
\(D_{m}\).
8 It is defined as
$$\begin{aligned} D_{m} := l_{m}^{\mathrm{FOCB}} \cdot \left( 1 + i_{G}\right) ^{-m}. \end{aligned}$$
(5)
The TDA’s “temporary final payout”, assumed to occur as lump-sum payment LSP, is given by
$$\begin{aligned} \mathrm{LSP}_{0} = \mathrm{SP} \cdot \frac{D_{h}}{D_{h+n}} \quad \text {for } \quad t \epsilon Y \end{aligned}$$
(6)
where SP denotes the single premium paid up front by policyholders,
h the policyholder’s age at the conclusion of contract, and
n the contract duration in years. Note that, in general,
\(\mathrm{LSP}_{t}\) denotes the expected payout at contract termination, disregarding bonus participation occurring after period
t. It does not denote a payment occurring in period
t. Let us now consider the development of the balance sheet items.
The transition mechanism of the long-term assets is given by
$$\begin{aligned} A_{t}^{\mathrm{lt}} = A_{t-1}^{\mathrm{lt}} \cdot \root 12 \of {(1+i_{A}^{\mathrm{lt}})}. \end{aligned}$$
(7)
The short-term assets are calculated as the sum of the policy reserves and the equity capital invested short term. Since the short-term interest rate is zero, the development of short-term assets is given by
$$\begin{aligned} A_{t}^{\mathrm{st}} = \mathrm{PR}_{t}^{\mathrm{DHP}} + \mathrm{EC}_{t}^{\mathrm{st}}. \end{aligned}$$
(8)
The development of the PR is given through
$$\begin{aligned} \mathrm{PR}_{t }^{\mathrm{DHP}}= & {} \mathrm{PR}_{t-1}^{\mathrm{DHP}} \cdot \root 12 \of {1+ i_{G}} \end{aligned}$$
(9)
$$\begin{aligned} \mathrm{PR}_{t}^{\mathrm{TDA}}= & {} {\left\{ \begin{array}{ll} \mathrm{PR}_{t-1}^{\mathrm{TDA}} \cdot \root 12 \of {1+ i_{G}} \cdot \gamma ^{\mathrm{TDA}}_{t} &{}\quad \text { for } \;\; t \epsilon Y \\ \mathrm{PR}_{t-1}^{\mathrm{TDA}} \cdot \root 12 \of {1+ i_{G}} &{}\quad \text {otherwise}\\ \end{array}\right. } \end{aligned}$$
(10)
where multiplication with
\(\gamma ^{\mathrm{TDA}}_{t} := L_{t}^{\mathrm{TDA}} \cdot (L_{t-1}^{\mathrm{TDA}})^{-1}\) reduces policy reserves to the amount needed to ensure payout for the remaining contracts. (Note that the risk result is taken into account in the bonus section and that for the DHP’s funds in the policy reserve, deaths are taken into account in the management decision in Eq. (
19).)
If
\(\mathrm{PR}_{t}^{\mathrm{DHP}} > 0 \), this liability item grows with the guaranteed interest rate
\(i_{G}\). Thus, should funds be shifted back from the
\(\mathrm{PR}^{\mathrm{DHP}}\) to the GF or EF, more funds need to be shifted back than what was taken earlier. Hence, the insurer needs assets that may be liquidated when this reallocation occurs. To take this into account, a growth through interest gains of the
\(\mathrm{PR}^{\mathrm{DHP}}\) goes hand in hand with an equivalent decrease of
\(\mathrm{EC}^{\mathrm{st}}\). Turning our attention to the development of
\(\mathrm{EC}^{\mathrm{st}}\), note that for
\(t \epsilon Y\),
\(\mathrm{SP}^{\mathrm{DHP}}\) the single premium paid by DHP policyholders, and
\(x\cdot \mathrm{SP}^{\mathrm{DHP}}\) the guaranteed benefit at the end of the contract term of the DHP, the amount of short-term liquidity needed to cover the DHPs’ interest gains is bound by the interest gains a single DHP policy would realise in the last year of contract term if all its funds were shifted to the insurer’s policy reserve (in that event, the DHP would pay only its guaranteed benefit and the interest gains would be smaller than
\(i_{G}\cdot x\cdot \mathrm{SP}_{\mathrm{DHP}}\)) multiplied by the current number of DHP policies held by the insurer at the beginning of the previous year (
\(L_{t-12}^{\mathrm{DHP}}\)), giving the rough estimation of maximum liquidity needed
$$\begin{aligned} \mathrm{EC}_{t}^{\mathrm{st}}-\mathrm{EC}_{t-12}^{\mathrm{st}} \le i_{G}\cdot x\cdot \mathrm{SP}^{\mathrm{DHP}}\cdot L_{t-12}^{\mathrm{DHP}}. \end{aligned}$$
(11)
For the sake of simplicity, we assume that the insurer makes its investment decisions at the beginning of each year and ensures that the liquidity cushion contains this amount.
$$\begin{aligned} \mathrm{EC}_{t}^{\mathrm{st}}= {\left\{ \begin{array}{ll} i_{G}\cdot x\cdot \mathrm{SP}_{\mathrm{DHP}}\cdot L_{t}^{\mathrm{DHP}} &{}\quad \text { for } \;\; t \epsilon Y \\ \mathrm{EC}_{t - 1}^{\mathrm{st}} - \mathrm{PR}_{t - 1}^{\mathrm{DHP}} \cdot \root 12 \of {1+ i_{G}} &{}\quad \text {otherwise}.\\ \end{array}\right. } \end{aligned}$$
(12)
If the insurer needs to add money to the liquidity buffer, it does so by liquidating long-term assets at a cost
\(\Theta \ge 0\). If the buffer exceeds the needed amount, the surplus is invested in long-term assets. Furthermore, a dividend
\(\delta \) as percentage of the equity capital is paid out to the shareholders. The long-term assets are thus adjusted in each period
\(t \epsilon Y\) to
$$\begin{aligned} A^{\mathrm{lt}}_{t}= & {} A^{\mathrm{lt}}_{t} - \mathrm{max} \left[ (1+\Theta )\cdot \left( \mathrm{EC}_{t}^{\mathrm{st}}- \mathrm{EC}_{t - 1}^{\mathrm{st}}\right) , \mathrm{EC}_{t}^{\mathrm{st}}- \mathrm{EC}_{t - 1}^{\mathrm{st}} \right] \nonumber \\&- \delta \left( \mathrm{EC}_{t}^{\mathrm{st}} + \mathrm{EC}_{t}^{\mathrm{lt}} \right) . \end{aligned}$$
(13)
The GF and EF are assumed to evolve following two GBMs, given by the stochastic differential equations
$$\begin{aligned} \frac{\mathrm{d}S^{\mathrm{GF}}(t)}{S^{\mathrm{GF}}(t)} = \mu ^{\mathrm{GF}} \cdot \mathrm{d}t + \sigma ^{\mathrm{GF}} \cdot \mathrm{d}W^{\mathrm{GF}}(t) \end{aligned}$$
(14)
for the GF and
$$\begin{aligned} \frac{\mathrm{d}S^{\mathrm{EF}}(t)}{S^{\mathrm{EF}}(t)} = \mu ^{\mathrm{EF}} \cdot \mathrm{d}t + \sigma ^{\mathrm{EF}} \cdot \mathrm{d}W^{\mathrm{EF}}(t) \end{aligned}$$
(15)
for the EF, with constant drift coefficient
\(\mu ^{i}\), volatility coefficient
\(\sigma ^{i}\), two Wiener processes
\(W^{i}(t)\) with correlation
\(\rho \), and initial value
\(S^{i}(0) = 1\),
\(i \epsilon \{\mathrm{GF}, \mathrm{EF} \} \). Inspired by Kochanski and Karnarski (
2011), the development of the GF and the EF is given by
$$\begin{aligned} \mathrm{GF}_{t}^{A} = \mathrm{GF}_{t-1}^{A} \cdot \mathrm{max} \left( 1- \lambda , \frac{S^{\mathrm{GF}}_{t}}{S^{\mathrm{GF}}_{t-1} + P_{t-1,1/12}^{\mathrm{CP}}} \cdot \root 12 \of {1- \nu } \right) \end{aligned}$$
(16)
and
$$\begin{aligned} \mathrm{EF}_{t}^{A} = \mathrm{EF}_{t-1}^{A} \cdot \frac{S^{\mathrm{EF}}_{t}}{S^{\mathrm{EF}}_{t-1}} \cdot \root 12 \of {1- \nu } \end{aligned}$$
(17)
where
\(\nu \) denotes a yearly management fee,
\(\lambda \) denotes the maximum loss in per cent that the downside protection of the GF allows, and
\( P_{t,1/12}^{\mathrm{CP}}\) is a parameter from the Black–Scholes formula for option pricing.
9 In a second step, the funds of the DHP are reallocated following a management decision
\(MD\left( \mathrm{AV}_{t},t\right) \) inspired by Kochanski and Karnarski (
2011). We model a product that is monitored on a monthly basis.
10 The bonus the DHP holders are entitled to is added to the current account value (AV) of the DHP policies before funds are reallocated at the beginning of each period (note that
\(\mathrm{Bonus}^{\mathrm{DHP}}_{t} = 0, \text { for } t \notin Y \)):
$$\begin{aligned} \mathrm{AV}_{t}:= \left( \mathrm{PR}_{t}^{\mathrm{DHP}} + \mathrm{GF}_{t}^{L} + \mathrm{EF}_{t}^{L} + \mathrm{Bonus}^{\mathrm{DHP}}_{t} \right) \cdot \left( L_{t}^{\mathrm{DHP}}\right) ^{-1}. \end{aligned}$$
(18)
The once again aggregated values for PR, GF, and EF are
$$\begin{aligned} \mathrm{PR}_{t+ 1}^{\mathrm{DHP}} \cdot \left( L_{t+1}^{\mathrm{DHP}}\right) ^{-1}= & {} {\left\{ \begin{array}{ll} \left( G_{t+1} - (1 - \lambda ) \cdot \mathrm{AV}_{t+1}\right) \cdot \left( \root 12 \of {1+i_{G}} -1 + \lambda \right) ^{-1} &{}\quad \text {if } \;\frac{G_{t + 1}}{(1 - \lambda ) \cdot \mathrm{AV}_{t+1 } } > 1 \\ 0 &{}\quad \text {otherwise}\\ \end{array}\right. } \nonumber \\\end{aligned}$$
(19)
$$\begin{aligned} \mathrm{GF}_{t+1}^{L} \cdot \left( L_{t +1}^{\mathrm{DHP}}\right) ^{-1}= & {} {\left\{ \begin{array}{ll} \mathrm{AV}_{t+1} - \mathrm{PR}_{t+1}^{\mathrm{DHP}} &{}\quad \text { if } \; \frac{G_{t + 1}}{(1 - \lambda ) \cdot \mathrm{AV}_{t+1}} > 1 \\ \frac{G_{t +1}}{1- \lambda } &{}\quad \text {otherwise}\\ \end{array}\right. } \end{aligned}$$
(20)
$$\begin{aligned} \mathrm{EF}_{t+ 1}^{L} \cdot \left( L_{t+1}^{\mathrm{DHP}}\right) ^{-1}= & {} \mathrm{AV}_{t+1} - \mathrm{PR}_{t+ 1}^{\mathrm{DHP}} - \mathrm{GF}_{t+1}. \end{aligned}$$
(21)
\(G_{t}\) is defined as the amount needed in period t to ensure the guaranteed benefit
\(x\cdot \mathrm{SP}^{\mathrm{DHP}}\) via the actuarial interest rate at contract termination
$$\begin{aligned} G_{t} = x\cdot \mathrm{SP}^{\mathrm{DHP}} \cdot \left( \frac{1}{1+i_{G}}\right) ^{(T-1)-t}. \end{aligned}$$
(22)
Dividing by
\(L_{t}^{\mathrm{DHP}}\) in Eq. (
18) and multiplying by
\(L_{t+1}^{\mathrm{DHP}}\) in Eqs. (
19), (
20), and (
21), we eliminate the death benefit paid out to deceased DHP policyholders. The development of the provision for premium refunds is given by
$$\begin{aligned} \mathrm{PPR}_{t} = \mathrm{PPR}_{t-1} + \mathrm{Inflows}_{t}^{\mathrm{PPR}} - \left( \mathrm{Bonus}_{t}^{\mathrm{TDA}} + \mathrm{Bonus}_{t}^{\mathrm{DHP}}\right) . \end{aligned}$$
(23)
The insurer’s long-term equity capital is given by the residual value
$$\begin{aligned} \mathrm{EC}_{t}^{\mathrm{lt}} = A_{t}^{\mathrm{lt}} + A_{t}^{\mathrm{st}} - \mathrm{PR}_{t}^{\mathrm{TDA}} - \mathrm{PR}_{t}^{\mathrm{DHP}} - \mathrm{PPR}_{t} - \mathrm{EC}_{t}^{\mathrm{st}}. \end{aligned}$$
(24)
Below, special care is given to describing the modelling of inflows to the PPR and the bonus allocation mechanism, the stage of the interaction effect.