Return Smoothing and Risk Sharing Elements in Life Insurance from a Client Perspective

Return Smoothing and Risk Sharing Elements in Life Insurance from a Client Perspective

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Speaker: Stefan Schelling
Description:

Jochen Ruß a, Stefan Schelling b, *

a Institute for Finance and Actuarial Sciences, Lise-Meitner-Strasse 14, 89081 Ulm, Germany and Ulm University, Institute of Insurance Science, Helmholtzstrasse 20, 89081 Ulm, Germany

b Ulm University, Institute of Insurance Science, Helmholtzstrasse 20, 89081 Ulm, Germany, stefan.schelling@uni-ulm.de

* Corresponding Author


Abstract

In many countries, traditional participating life insurance (TPLI) contracts are typically equipped with a cliquet-style (year-to-year) guarantee. Life insurers pool the assets and liabilities of a heterogeneous portfolio of TPLI contracts. This allows for intergenerational risk sharing. Together with certain smoothing elements in the collective investment, it also results in rather stable returns for the policyholders. Despite the current low interest rate environment, TPLI contracts are still popular in the segment of retirement savings. Standard approaches which focus solely on the cash-flow at maturity cannot explain their popularity. In a recent paper, \cite{russ2018multi} have introduced a descriptive model of decision making which takes into account that potential future changes in the account value impact the decision of long-term investors at outset. Based on this, we illustrate how smoothing and risk sharing elements provided by a life insurer can significantly increase the subjective utility for such investors. Furthermore, we show that for these investors TPLI contracts are more attractive than common unit-linked (guaranteed) products. Hence, our findings explain the popularity of TPLI contracts and provide helpful insights into decision making in the context of retirement savings.

Keywords: Cumulative Prospect Theory, Myopic Loss Aversion, Mental Accounting, Smoothing, Risk Sharing, Retirement Savings, Traditional Participating Life Insurance

JEL: D14, D81, G11, G22, G41, J26, J32

 

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