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.     

The Dynamics of Optimal Gradual Stabilizations

Inflation inertia may be quite tenacious because of the simultaneousinteraction between policy actions and inflationary expectationsunder imperfect credibility. This result is particularly relevantfor understanding some of the failed efforts to stabilize inflationin South America. This article deals with the issue of inertiain the framework of imperfect information about the type ofthe policymaker and extends the existing models to an infinitehorizon. Because policymakers do not have perfect control ofinflation, a "frivolous stabilizer" may deviate from the policiesof a "serious stabilizer" without necessarily being unmaskedimmediately. When the difference in the ability of "strong"and "weak" policymakers to control inflation is large, unexpectedinflation may be persistently negative for quite a while, thuscausing reduced economic activity and giving the indicationthat credibility is low. If the policymaker persists with thestabilization, this pattern gradually disappears as his reputationrises. But before this final stage the serious policymaker hasto compromise his inflation objective in view of adverse expectationsabout his type and pay the cost of imperfect credibility.     

Pricing Asian Options and Equity-Indexed Annuities with Regime Switching by the Trinomial Tree Method

Abstract

Equity-indexed annuities (EIAs) provide investors with a minimum rate of return and at the same time the opportunity of gaining a profit that is linked to the performance of an equity index. These properties make EIAs a popular product in the market. For modeling the equity index process and calculating the price of EIAs, as the maturity of EIAs usually is long, it is more reasonable to assume that the interest rate and the volatility of the equity index are stochastic processes. One simple way is to apply the regime-switching model, which allows these parameters depending on the market situation. However, the valuation of derivatives in such models is challenging, especially for the strong path-dependent options such as Asian options. A trinomial tree model is introduced to provide an efficient way to solve this problem. The valuation of Asian options is studied and extended to Asian-option-related EIAs.     

Quantifying the Costs of Investment Limits for Chilean Pension Funds*

Since the creation of the Chilean pension fund industry in 1981, pension fund administrators have not been free to choose their investment portfolios because of stringent regulation of investment limits. The diagnosis implicit with the imposition of limits was that the Chilean capital market was not deep, that there was an important demand for funds to finance the expansion of the productive sector and that, due to principal‐agent problems, protection for uninformed account holders was needed. As this regulation entails an inefficient combination of risk and return, this paper quantifies its costs.     

Annuities and lifetime income: the Anglo-Saxon experience

A number of western industrialized nations have found themselves in a similar position to the United States today: an aging population leading to increasing, and perhaps unsustainable, expenditures on a traditional social security system. This article examines the risks that individuals face in retirement, describes the role of annuities in addressing those risks and examines why annuitization rates are so low. It then reviews the pension structures in the United Kingdom, Australia and New Zealand--countries with similar governmental and economic structures to those of the United States--and describes how these have impacted those countries' annuitization rates.     

信用卡转换成本研究综述

早在上世纪80年代,经济学家开始研究存在转换成本的市场竞争问题.目前,有关转换成本的研究主要集中在电信、银行存款及信用卡等市场领域.研究信用卡转换成本对银行业发展、信用卡产业的发展等具有重要现实意义.本文基于转换成本一般研究基础之上,从转换成本的内涵与类型、对消费者的影响及研究方法等方面对学术界有关信用卡转换成本的研究进行了梳理和概括,以期为今后的信用卡转换成本的深入研究提供参考.     

Mortality Heterogeneity and the Distributional Consequences of Mandatory Annuitization

This article investigates the distributional consequences of mandatory annuitization. Using Health and Retirement Study (HRS) data and accounting for longevity risk pooling within marriage and preannuitized wealth, we find substantial redistribution away from disadvantaged groups in expected utility terms. Using HRS data on subjective survival probabilities, we construct a subjective life table for each individual in the HRS. We calculate the value each household would place on annuitization, based on the husband and wife's subjective life tables, and the household's degree of risk aversion and proportion of preannuitized wealth. A significant minority would perceive themselves as suffering a loss from mandatory annuitization.     

Main Bank Power,Switching Costs,and Firm Performance: Theory and Evidence from Ukraine

We examine firms' motivation to change their main bank and how this switch affects loans, interest payments, and firm performance. Applying treatment effect analysis to unique firm-bank matched Ukrainian data, we find that larger and more highly leveraged companies are more likely to switch their main bank. Importantly, firms tend to switch to a new main bank that holds a higher share of equity in the firm and thus has stronger power. The results also suggest that after switching, firms obtain additional access to bank loans but, on average, have lower profits due to bigger interest payments.     

我国银行个人客户转换成本的实证分析

随着商业银行从批发向零售业务战略转型的推进,个人客户资源的争夺日益激烈.通过提高客户的转换成本来提高客户的保留率,已经成为商业银行提高市场竞争力的重要手段.对中国28个城市735份有效样本数据的实证分析显示,除了年龄与受教育程度等个体因素外,银行-客户关系和客户对银行服务的评价对转换成本影响显著.因此,提高服务质量、改善银行-客户关系对于银行提高竞争力具有重要意义.     

Real Longevity Insurance with a Deductible: Introduction to Advanced-Life Delayed Annuities (ALDA)

Abstract

This paper explores the financial properties of a concept product called an advanced-life delayed annuity (ALDA). The ALDA is a variant of a pure deferred annuity contract that is acquired by installments, adjusted for consumer price inflation, and pays off toward the end of the human life cycle. The ALDA concept is aimed at the growing population of North Americans without access to a traditional defined benefit (DB) pension plan and the implicit longevity insurance that a DB plan contains. I show that under quite reasonable pricing assumptions, a consumer can invest or allocate $1 per month, while saving for retirement, and receive between $20 and $40 per month in benefits, assuming the deductible in this insurance policy is set high enough. The ALDA concept might go a long way in mitigating the psychological barrier to voluntary lump-sum annuitization.     

Costs of Accounting to Lenders: Canadian Evidence

Do new accounting pronouncements impose costs on firms with accounting-based restrictions in their public lending agreements? Previous studies have not found significant, adverse share price reactions to such pronouncements. This paper posits that management is concerned with the total costs of the monitoring policies used for reporting to lenders, and that share price reactions are likely to comprise only a small portion of those costs. The episode of mandatory lease capitalisation in Canada is used to test some predictions that are consistent with this expanded view of the costs of accounting to lenders. Lessees ‘public lending agreements were examined to see if they stipulated restrictions based on accounting numbers; and, if they did, whether the constraints were based on GAAP (generally accepted accounting principles) or TAP (tailored accounting principles). The evidence strongly supports the hypothesis that there are costs of accounting to lenders; but these costs are unlikely to be observed by researchers who look only for adverse share price reactions to mandated accounting changes. It also indicates that Canadian standards setters were sensitive to lessees’ accounting costs.     

Optimal Refunding Strategies, Transaction Costs, and the Market Value of Corporate Debt

The primary purpose of this paper is to consider both qualitatively and quantitatively the effects of refunding transaction costs and interest rate uncertainty on optimal refunding strategies and the market value of corporate debt. A dynamic model of corporate bond refunding with transaction costs is developed that simultaneously solves for the optimal refunding strategy, the value of the refunding call option, the value of the bond liability to the firm, and the market (investor) value of the fixed-rate contract. We provide examples in which the price of the callable bond does exceed the call price, and we examine whether or not typical levels of refunding costs are sufficient to explain the magnitude and duration of frequently observed premiums on callable corporate bonds.     

"松"还是"紧"养老基金资产配置的难题

不可否认,对资产配置的限制可以使养老金资产避免资本市场的代理和投资集中化的系统风险,但同时也会产生一些不利影响.因此,对“松”与“紧”的选择就成了一个政策难题。     

ABC: The Pathway to Comparison of the Costs of Integrated Care

In recent years, health care demand has become increasingly complicated and care has had to be integrated. The main reasons for this are a rising number of chronically ill patients and ageing of populations. Integrated health care is processual so there are continuous changes in care delivery; it incorporates many co–ordinating and co–operative activities which can produce uncertain outcomes; and activities are directed at delivering tailor–made care so there are no standardized or generalized outcomes. These characteristics mean that it is difficult to determine and compare the costs of different integrated care structures. This article argues that using Activity Based Costing (ABC) and integrated care pathways provides the best information possible for decision–making by health care managers, insurers, care suppliers and governments.     

缓行渐进与制度准备:央行支农再贷款淡出策略探讨

支农再贷款作为一项非常政策安排,对农村尤其是对贫困地区的“政策扶贫”和“政策补贴”的倾向性效应十分显著,但同时存在着诸多实践偏差和理论缺陷,已经对央行货币政策有效实施构成钳制,有必要对其未来取向进行建设性研究。     

More Than Words: Quantifying Language to Measure Firms' Fundamentals

We examine whether a simple quantitative measure of language can be used to predict individual firms' accounting earnings and stock returns. Our three main findings are: (1) the fraction of negative words in firm-specific news stories forecasts low firm earnings; (2) firms' stock prices briefly underreact to the information embedded in negative words; and (3) the earnings and return predictability from negative words is largest for the stories that focus on fundamentals. Together these findings suggest that linguistic media content captures otherwise hard-to-quantify aspects of firms' fundamentals, which investors quickly incorporate into stock prices.     

Trade Facilitation and Economic Development: A New Approach to Quantifying the Impact

This article analyzes the relationship between trade facilitationand trade flows in the Asia-Pacific region. Country-specificdata for port efficiency, customs environment, regulatory environment,and e-business usage are used to construct indicators for measuringtrade facilitation. The relationship between these indicatorsand trade flows is estimated using a gravity model that includestariffs and other standard variables. Enhanced port efficiencyhas a large and positive effect on trade flows. Regulatory barriersdeter trade. Improvements in customs and greater e-businessuse significantly expand trade but to a lesser degree than improvementsin ports or regulations. The benefits of specific trade facilitationefforts are estimated by quantifying differential improvementsin these four areas among members of the Asia Pacific EconomicCooperation (APEC). A scenario in which APEC members with below-averageindicators improve capacity halfway to the average for all membersshows that intra-APEC trade could increase by $254 billion,or 21 percent of intra-APEC trade flows. About half the increaseis derived from improved port efficiency.     

Mitigating Interest Rate Risk in Variable Annuities: An Analysis of Hedging Effectiveness under Model Risk

Variable annuities are investment vehicles offered by insurance companies that combine a life insurance policy with long-term financial guarantees. These guarantees expose the insurer to market risks, such as volatility and interest rate risks, which can be managed only with a hedging strategy. The objective of this article is to study the effectiveness of dynamic delta-rho hedging strategies for mitigating interest rate risk in variable annuities with either a guaranteed minimum death benefit or guaranteed minimum withdrawal benefit rider. Our analysis centers on three important practical issues: (1) the robustness of delta-rho hedging strategies to model uncertainty, (2) the impact of guarantee features (maturity versus withdrawal benefits) on the performance of the hedging strategy, and (3) the importance of hedging interest rate risk in either a low and stable or rising interest rate environment. Overall, we find that the impact of interest rate risk is equally felt for the two types of products considered, and that interest rate hedges do lead to a significant risk reduction for the insurer, even when the ongoing low interest rate environment is factored in.