Research area: quantitative finance
Department: ORTEC Centre for Financial Research (OCFR)
Supervisor: dr. Hens Steehouwer and dr. David van Bragt
Description: ALM and risk management models for insurance companies nowadays typically require the economic or market value of the liabilities. Liabilities of life insurance companies are characterized by the presence of embedded options like profit sharing or (long term) return guarantees. Furthermore, the variety of life insurance products across the globe is enormous while at the same time the “underlying” components are very similar (mortality, savings element, returns, options). As a result the valuation and simulation of life insurance liabilities is a complex matter. One idea for summarizing the behavior of a large portfolio of insurance liabilities is by evaluating these liabilities on a large set of financial economic scenarios and then trying to find a portfolio consisting of standard financial instruments (bonds, swaptions, stocks, etc.) that mimics the total scenario behavior (in terms of market value) of the liabilities as good as possible. The optimization criterion could simply be a simple least-squares criterion in terms of the value of the liabilities across all scenarios. Such an approach could be used, for example, for an efficient construction of the replicating portfolio of the liabilities (using standard theoretical financial instruments) or to construct the practical counterpart of such a replicating portfolio, a so-called liability benchmark (using only traded financial instruments). The objective of this project is to collect and study the (scarce) existing literature on this topic, develop and implement a version of this approach and finally apply the approach to real-life liability portfolios.
Background information:
Van Bragt, D. and H. Steehouwer (2007), “Recent Trends in Asset and Liability Modeling for Life Insurers”, OCFR Methodological Paper No. 2007-01.
Oechslin, J., O. Aubry, M. Aellig, A. Käppeli, D. Brönnimann, A. Tandonnet and G. Valois (2007), “Replicating Embedded Options”, Life & Pensions, February.
(www.life-pensions.com)