Optimal Risk Classification with an Application to Substandard Annuities

Abstract

Substandard annuities pay higher pensions to individuals with impaired health and thus require special underwriting of applicants. Although such risk classification can substantially increase a company's profitability, these products are uncommon except for the well-established U.K. market. In this paper we comprehensively analyze this issue and make several contributions to the literature. First, we describe enhanced, impaired life, and care annuities, and then we discuss the underwriting process and underwriting risk related thereto. Second, we propose a theoretical model to determine the optimal profit-maximizing risk classification system for substandard annuities. Based on the model framework and for given price-demand dependencies, we formally show the effect of classification costs and costs of underwriting risk on profitability for insurers. Risk classes are distinguished by the average mortality of contained insureds, whereby mortality heterogeneity is included by means of a frailty model. Third, we discuss key aspects regarding a practical implementation of our model as well as possible market entry barriers for substandard annuity providers.     

Issues in the relationship between theory and practice in management accounting

In recent decades the interest of academic researchers in the practical aspects of management accounting has waned. This editorial explores some of the reasons of this development. Over the past few decades we have witnessed the establishment of management accounting in academia as a social science. This has increased the credibility of the accounting academics. However, it has also meant that academic researchers have neglected the technical core of their discipline and its problems and issues which have a direct practical relevance. It is concluded that there is a need for academic researchers to have a stronger focus on the technical core of the subject and to harness the findings of empirical research so that they can be used to develop and support practice.     

Optimal rate classification for enhanced annuities

For a given premium, enhanced annuities pay higher pensions to policyholders with impaired health. Even though risk classification is a common concept in the insurance sector and should allow insurers to increase their profitability, enhanced annuities are rarely offered outside of the United Kingdom. The paper provides a general method of determining an optimal risk classification system for enhanced annuities that will maximize an insurance company’s profits. The cost of risk classification, as well as that incurred when insureds are assigned to inappropriate risk classes (a chief component of underwriting risk), are explicitly considered.     

New environmental policy instruments to realize forest expansion in Flanders (northern Belgium): A base for smart regulation?

This paper evaluates the current instrument mix, designs options for smart regulation and estimates the support base of new instruments for the forest expansion policy in Flanders (northern Belgium). The framework applied is a combination of theories on instrument choice (ICT), policy transfer and legitimacy. The ICT points out that there is a need for new environmental policy instruments (NEPI) oriented to private actors that inform them or create win–win situations for all involved parties. The need is especially high for farmers, who are key actors. The policy transfer analysis suggested instruments currently in use in the Netherlands, England and Denmark that can fulfill these needs. However, the acceptability – or legitimacy – of the suggested instruments in Flanders is only high for three of these, notably the carbon fund, flexible grant scheme and expert advice (especially by forest groups). This largely fills some smart regulation gaps, like the need for information (expert advice), the involvement of other institutional actors (certifiers, forest groups) and the higher involvement of the private sector (all). However, some gaps, such as flexible land purchase through cooperation with real estate agents or other private agents and opportunities for win–win outcomes with farmers, remain. Thus, it is not possible to fully optimize the instrument mix in accordance with the smart regulation requirements in Flanders’ forest expansion policy at this moment. However, as continuity or incremental change is characteristic of most public policy, this does not mean that the suggested changes will be impossible in the near future, especially with the changing character of the rural space.     

Mangelernährung vorbeugen und behandeln

Zusammenfasung  Ern?hrung von Tumorpatienten — Chemotherapie, Operation und Bestrahlung bilden die S?ulen der Krebstherapie. Doch Gewichtsverlust und Ern?hrungsprobleme k?nnen bei Tumorpatienten erhebliche Auswirkungen auf den Erfolg der Therapie und den weiteren Krankheitsverlauf haben. Daher sollten Pflegende frühzeitig auf Zeichen einer Mangelern?hrung achten. Denn gezielte Ma?nahmen k?nnen die Ern?hrungssituation rasch verbessern und die Lebensqualit?t der Patienten steigern. Literatur und erg?nzende Tabellen unter www. heilberufe-online.de, Kontext     

Auswirkungen von Enhanced Annuities auf den Bestand eines Versicherers

The value for money of a standard annuity is the higher, the longer the life expectancy of an insured, and therefore it is only acceptable for persons with an above average life expectancy. The discrepancy is intensified by tax regulations that favor lifelong annuity payments opposed to a lump sum. This discrimination of impaired insureds could be prevented if so-called enhanced annuities were offered, i.e. products where the annuity paid is the larger, the lower the person’s life expectancy. The article presents a quantitative comparison of the risk profile of insurance companies offering standard annuity contracts compared to enhanced annuities and an analysis of the impact of adverse selection on a standard insurer. By definition of individual mortality rates a heterogeneous insurance portfolio is specified. Besides we model the individual underwriting of enhanced annuities. A Monte Carlo Simulation provides results to compare the profit/loss situation of a portfolio of traditional annuity products and a portfolio of enhanced annuities with individual underwriting of different quality and to assess the impact of selection effects.     

Understanding the Death Benefit Switch Option in Universal Life Policies

Universal life policies are the most popular insurance contract design in the United States. They provide either a level death benefit paying a fixed face amount or an increasing death benefit paying a fixed benefit plus the available cash value, and both types include the option to switch from one type to the other. In this article, we investigate the fact that—unlike a switch from level to increasing—a switch from an increasing death benefit to a level death benefit requires neither fees nor evidence of insurability. To assess the impact of the death benefit switch option, we develop a model framework of an increasing universal life insurance policy embedding this option. Consideration of heterogeneity with respect to mortality via a stochastic differential mortality factor enables an investigation of adverse exercise behavior. In a comprehensive simulation analysis, we quantify the net present value of the option from the insurer's perspective using risk‐neutral valuation under stochastic interest rates assuming empirical exercise probabilities. Based on our results, we provide policy recommendations for life insurers.     

The Impact of the Secondary Market on Life Insurers' Surrender Profits

Life insurers often claim that the life settlement industry reduces their surrender profits and leads to an adverse shift in their portfolio of insured risks; that is, high risks remain in the portfolio instead of surrendering. In this article, we aim to quantify the effect of altered surrender behavior––subject to the health status of an insured––in a portfolio of life insurance contracts on the surrender profits of primary insurers. Our model includes mortality heterogeneity by applying a stochastic frailty factor to a mortality table. We additionally analyze the impact of the premium payment method by comparing results for annual and single premium payments.