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This paper uses laboratory experiments to provide a systematic analysis of how di↵erent presentation formats a↵ect individuals’ investment decisions. The results indicate that the type of presentation as well as personal characteristics influence both, the consistency of decisions and the riskiness of investment choices. However, while personal characteristics have a larger impact on consistency, the chosen risk level is determined more by framing e↵ects. On the level of personal characteristics, participants’ decisions show that better financial literacy and a better understanding of the presentation format enhance consistency and thus decision quality. Moreover, female participants on average make less consistent decisions and tend to prefer less risky alternatives. On the level of framing dimensions, subjects choose riskier investments when possible outcomes are shown in absolute values rather than rates of return and when the loss potential is less obvious. In particular, reducing the emphasis on downside risk and upside potential simultaneously leads to a substantial increase in risk taking.
This paper is the first to conduct an incentive-compatible experiment using real monetary payoffs to test the hypothesis of probabilistic insurance which states that willingness to pay for insurance decreases sharply in the presence of even small default probabilities as compared to a risk-free insurance contract. In our experiment, 181 participants state their willingness to pay for insurance contracts with different levels of default risk. We find that the willingness to pay sharply decreases with increasing default risk. Our results hence strongly support the hypothesis of probabilistic insurance. Furthermore, we study the impact of customer reaction to default risk on an insurer’s optimal solvency level using our experimentally obtained data on insurance demand. We show that an insurer should choose to be default-free rather than having even a very small default probability. This risk strategy is also optimal when assuming substantial transaction costs for risk management activities undertaken to achieve the maximum solvency level.
This paper compares the shareholder-value-maximizing capital structure and pricing policy of insurance groups against that of stand-alone insurers. Groups can utilise intra-group risk diversification by means of capital and risk transfer instruments. We show that using these instruments enables the group to offer insurance with less default risk and at lower premiums than is optimal for standalone insurers. We also take into account that shareholders of groups could find it more difficult to prevent inefficient overinvestment or cross-subsidisation, which we model by higher dead-weight costs of carrying capital. The tradeoff between risk diversification on the one hand and higher dead-weight costs on the other can result in group building being beneficial for shareholders but detrimental for policyholders.
Insurance guarantee schemes aim to protect policyholders from the costs of insurer insolvencies. However, guarantee schemes can also reduce insurers’ incentives to conduct appropriate risk management. We investigate stock insurers’ risk-shifting behavior for insurance guarantee schemes under the two different financing alternatives: a flat-rate premium assessment versus a risk-based premium assessment. We identify which guarantee scheme maximizes policyholders’ welfare, measured by their expected utility. We find that the risk-based insurance guarantee scheme can only mitigate the insurer’s risk-shifting behavior if a substantial premium loading is present. Furthermore, the risk-based guarantee scheme is superior for improving policyholders’ welfare compared to the flat-rate scheme when the mitigating effect occurs.
This Policy Letter outlines a pandemic insurance solution through a pandemic-related “Insurance Linked Bond”. It would be originated by governments, with a principal amount to cover significant costs resulting from a pandemic. These bonds, which would be traded on a secondary market, generate a risk-adequate return for private and institutional investors that is financed through the insurance premiums paid by the public domain. In case of a pre-defined pandemic trigger event, the principal of the bond becomes available for the originating governments to cover pandemic-related costs. Through this approach, governments can insure themselves against future pandemic-related risks, while funding comes primarily from private and institutional investors.
Coming (great) events cast their (long) shadow before. As the financial crisis gave birth to the creation of the European System of Financial Supervision (ESFS), the imminent Brexit now serves as an impulse to rather extensively reorganize it. Pursuant to the preferences of the Commission—as revealed in its draft for a regulation amending the regulations founding the European Supervisory Authorities (ESA)—the supervision (and regulation) of the financial sectors should be further centralized and integrated and additional powers should be given to the ESAs. To a large degree these alterations are intended to adjust the competences of the European Securities and Markets Authority (ESMA) to better meet its new objectives under the Capital Markets Union (“CMU”). In view that an equivalent to the CMU or the Banking Union—in the sense of a European Insurance Union—is not yet on the horizon for the insurance sector (or the occupational pensions sector), one could prima vista take the view that insurance supervision and regulation is once again taken captive by the necessity of regulatory reforms stemming from other financial sectors. However, even if that is partially the case, the outcome of the intended reforms might still be advantageous for the insurance sector and an important step in the right direction. Therefore, it needs to be intensively discussed.
At this stage, some of the most prominent envisioned changes to the structure, tasks and powers of the European Insurance and Occupational Pensions Authority (EIOPA) and their necessity, usefulness or counter-productivity still have to be examined.
Investors and insurance policyholders are often confronted with complex products and providers' opaque organisational structures. At the same time, the possibility that their claims will not be honoured often poses an existential risk. Financial regulation therefore aims at putting in place a financial services framework that will safeguard market processes whilst also protecting consumers. However, benefits of regulation are accompanied by certain risks, as can be exemplified with the case of insurance regulation.
Kapitalanleger wie Versicherungsnehmer werden oft konfrontiert mit komplexen Produkten und nicht durchschaubaren Unternehmensstrukturen der Anbieter. Gleichzeitig stellt die mögliche Nichterfüllung ihrer Ansprüche häufig ein existenzielles Risiko dar. Deshalb ist es Ziel der Finanzregulierung, Rahmenbedingungen im Finanzdienstleistungsbereich zu schaffen, die wirtschaftliche Abläufe gewährleisten und gleichzeitig den Konsumenten schützen. Dem Nutzen der Regulierung stehen aber auch Risiken gegenüber, die im diesem Artikel am Beispiel der Versicherungsregulierung dargelegt werden.
The Liikanen Group proposes contingent convertible (CoCo) bonds as instruments to enhance financial stability in the banking industry. Especially life insurance companies could serve as CoCo bond holders as they are already the largest purchasers of bank bonds in Europe. The growing number of banks issuing CoCo bonds leads to a rising awareness of these hybrid securities among life insurers as they are increasingly looking for higher?yielding investments into bond?like asset classes during the current low interest rate period. Our contribution provides an insight for life insurance companies to understand the effects of holding CoCo bonds as implied by the Solvency II standards that will become effective by 2016.
The Liikanen Group proposes contingent convertible (CoCo) bonds as a potential mechanism to enhance financial stability in the banking industry. Especially life insurance companies could serve as CoCo bond holders as they are already the largest purchasers of bank bonds in Europe. We develop a stylized model with a direct financial connection between banking and insurance and study the effects of various types of bonds such as non-convertible bonds, write-down bonds and CoCos on banks' and insurers' risk situations. In addition, we compare insurers' capital requirements under the proposed Solvency II standard model as well as under an internal model that ex-ante anticipates additional risks due to possible conversion of the CoCo bond into bank shares. In order to check the robustness of our findings, we consider different CoCo designs (write-down factor, trigger value, holding time of bank shares) and compare the resulting capital requirements with those for holding non-convertible bonds. We identify situations in which insurers benefit from buying CoCo bonds due to lower capital requirements and higher coupon rates. Furthermore, our results highlight how the Solvency II standard model can mislead insurers in their CoCo investment decision due to economically irrational incentives.
The European Commission has published a Green Paper outlining possible measures to create a single market for capital in Europe. Our comments on the Commission’s capital markets union project use the functional finance approach as a starting point. Policy decisions, according to the functional finance perspective, should be essentially neutral (agnostic) in terms of institutions (level playing field). Our main angle, from which we assess proposals for the capital markets union agenda, are information asymmetries and the agency problems (screening, monitoring) which arise as a result. Within this perspective, we make a number of more specific proposals.
Der Entwurf eines Lebensversicherungsreformgesetz der Bundesregierung vom 04.06.2014 adressiert die Folgen der derzeitigen Niedrigzinsphase für Lebensversicherungunternehmen und Lebensversicherte. Helmut Gründl kommentiert die vorgeschlagene Regelung zu den Bewertungsreserven, die Regelung zur Ausschüttungssperre sowie die Regelung zum Höchstzillmersatz. Der Beitrag konzentriert sich auf die Auswirkungen der Vorschläge auf die Renditeerwartungen des Kollektivs der Versicherungsnehmer sowie auf die Anreize potentieller Eigenkapitalgeber, sich an Versicherungsunternehmen zu beteiligen.
Low interest rates are becoming a threat to the stability of the life insurance industry, especially in countries such as Germany, where products with relatively high guaranteed returns sold in the past still represent a prominent share of the total portfolio. This contribution aims to assess and quantify the effects of the current low interest rate phase on the balance sheet of a representative German life insurer, given the current asset allocation and the outstanding liabilities. To do so, we generate a stochastic term structure of interest rates as well as stock market returns to simulate investment returns of a stylized life insurance business portfolio in a multi-period setting. Based on empirically calibrated parameters, we can observe the evolution of the life insurers' balance sheet over time with a special focus on their solvency situation. To account for different scenarios and in order to check the robustness of our findings, we calibrate different capital market settings and different initial situations of capital endowment. Our results suggest that a prolonged period of low interest rates would markedly affect the solvency situation of life insurers, leading to relatively high cumulative probability of default for less capitalized companies.
In den vergangenen Jahrzehnten wurden hohe Garantieverzinsungen in den Lebensversicherungsverträgen vereinbart. Dauert die herrschende Niedrigzinsphase noch einige Jahre an, wird es für einige Lebensversicherungsunternehmen schwierig werden, die gegebenen Langzeitgarantien über ihre Kapitalanlage zu erwirtschaften. Der Gesetzgeber sollte festlegen, dass Versicherungskunden nur an Bewertungsreserven beteiligt werden, die eine Höhe übersteigen, die zur Gewährleistung eines intergenerativen Risikoausgleichs notwendig ist. Weiterhin sollten Versicherungskunden nur an Bewertungsreserven beteiligt werden, die aus Kapitalanlagen entstehen, die nicht festverzinsliche Wertpapiere umfassen.
Mittels des Gesetzes zur zusätzlichen Aufsicht über beaufsichtigte Unternehmen eines Finanzkonglomerats (Konglomerate, die aus mehreren Unternehmen aus verschiedenen Finanzmarktsektoren bestehen, beispielsweise aus dem Bankensektor und dem Versicherungssektor) sollen Regelungslücken geschlossen werden, die insbesondere die Gefahr betreffen, die sich aus der „Ansteckung“ einzelner Finanzkonglomerats-Unternehmen ergeben. Die vorliegende Stellungnahme weist auf eine Inkonsistenz in der beabsichtigten Ansiedlung der Aufsichtskompetenz hin und bietet einen Vorschlag zur Präzisierung der Eigenmittelvorschriften.
Pursuant to art. 45 of the Solvency II Framework Directive, all insurance undertakings will be obliged to conduct an “Own Risk and Solvency Assessment” (ORSA). ORSA’s relevance is not limited only to the second pillar of Solvency II, where mainly qualitative requirements are to be found. ORSA rather exhibits strong interlinks with the first pillar and its quantitative requirements and may also serve as a trigger for transparency duties which form Solvency II’s third pillar. ORSA may thus be described in some respects as the glue that binds together all three pillars of Solvency II. ORSA is one of the most obvious examples of the supervisory shift from a rules-based to a principles-based approach. As such, ORSA has hitherto been only very roughly defined. Since it is for the undertaking to determine its own specific risk profile and to evaluate whether this risk profile deviates significantly from the assumptions underlying the standard formula, it seems only natural that the supervisor must specify in greater detail what these underlying assumptions are. The most practicable way to do so would be for EIOPA to establish a “standard insurer”, which implies a translation of the assumptions concerning the underlying probability distributions into directly observable characteristics. The creation of the standard insurer would be an important step towards relaxing the insurers’ fear of what ORSA might bring about.