The impact of risk classification in life & pension under Solvency II

The impact of risk classification in life & pension under Solvency II

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Speaker: Alexander Bohnert

An analysis of underwriting risk underwriting costs and classification systems      

Against the background of the demographic development with an ageing society and rising life expectancies in most industrialized countries, solutions for retirement income are becoming increasingly important. However, standard annuities are generally priced based on an above-average life expectancy due to adverse selection effects, which makes them less attractive to customers with a below-average life expectancy. Among the potential product solutions are so-called enhanced annuities, which offer a higher annuity in case of a reduced life expectancy (see, e.g., Hoermann and Ruß, 2008) and which are very common in the UK, for instance, but not in other countries (see, e.g., Gatzert and Klotzki, 2017). In this context, particularly Solvency II as the new risk-based European regulatory framework for insurance companies may considerably impact an insurer's decision to engage in risk classification by offering enhanced annuity products during the retirement phase, since especially long-term guarantees, longevity risk exposure as well as underwriting risks imply higher capital requirements. At the same time, the annuity provider faces a tradeoff between underwriting quality, the number and composition of risk classes (i.e. the respective classification system), and the associated classification costs. The aim of this paper is to develop a model framework to study these issues by quantifying the impact of risk classification in case of enhanced annuities on an insurer's risk and profit situation under Solvency II, thereby also taking into account the portfolio size, natural hedging effects, and adverse selection.

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