The Thermodynamic Approach to Whole-Life Insurance: A Method for Evaluation of Surrender Risk

TL;DR

This paper presents a thermodynamic-inspired collective model for whole-life insurance, capturing individual heterogeneity and enabling the evaluation of surrender risk and adverse selection through diffusion processes.

Contribution

It introduces a novel thermodynamic approach to model heterogeneity in life insurance, providing a new framework for risk evaluation and premium calculation.

Findings

The model effectively describes surrender risk using diffusion processes.

Two numerical models demonstrate the framework's flexibility.

The approach links statistical mechanics concepts to insurance risk assessment.

Abstract

We introduce a collective model for life insurance where the heterogeneity of each insured, including the health state, is modeled by a diffusion process. This model is influenced by concepts in statistical mechanics. Using the proposed framework, one can describe the total pay-off as a functional of the diffusion process, which can be used to derive a level premium that evaluates the risk of lapses due tothe so-called adverse selection. Two numerically tractable models are presented to exemplify the flexibility of the proposed framework.