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

  • Olivier Le Courtois EMAIL logo , Mohamed Majri and Li Shen
Published/Copyright: July 22, 2020

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.


Corresponding author: Olivier Le Courtois, Emlyon Business School, Address: 23, Avenue Guy de Collongue, 69134, Ecully Cedex, France, E-mail:

Acknowledgments

We express our gratitude to Jérémy Allali, Philippe Desurmont, Alexandre Kozlov, François-Xavier de Lauzon, Jacques Lévy-Véhel, Hubert Rodarie, and Christian Walter for their useful comments. Special thanks to Anthony Floryszczak for substantial help and advice.

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Received: 2019-12-10
Accepted: 2020-06-15
Published Online: 2020-07-22

© 2020 Walter de Gruyter GmbH, Berlin/Boston

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