Decrease of capital guarantees in life insurance products: can reinsurance stop it?

TL;DR

This paper investigates how reinsurance can help life insurance companies maintain or increase capital guarantees by managing financial risks more effectively, especially over longer horizons and with less risk-averse insurers.

Contribution

It introduces a dynamic optimization framework incorporating Value-at-Risk and no-short-selling constraints to evaluate reinsurance's role in preserving capital guarantees.

Findings

Reinsurance enables insurers to offer higher capital guarantees without expected utility loss.

Longer investment horizons enhance reinsurance benefits.

Less risk-averse insurers gain more from reinsurance strategies.

Abstract

We analyze the potential of reinsurance for reversing the current trend of decreasing capital guarantees in life insurance products. Providing an insurer with an opportunity to shift part of the financial risk to a reinsurer, we solve the insurer's dynamic investment-reinsurance optimization problem under simultaneous Value-at-Risk and no-short-selling constraints. We introduce the concept of guarantee-equivalent utility gain and use it to compare life insurance products with and without reinsurance. Our numerical studies indicate that the optimally managed reinsurance allows the insurer to offer significantly higher capital guarantees to clients without any loss in the insurer's expected utility. The longer the investment horizon and the less risk-averse the insurer, the more prominent the reinsurance benefit.