Borrower capital, shadow insurance, and life insurer performance

ABSTRACT

The paper develops a ‘capped’ call option model by calibrating Briys and de Varenne (1994) with integrating Dermine and Lajeri (2001) that the borrowing-firm credit risk is introduced to the lending function of the insurer. Results show that shadow banking entrusted loans enhance policyholder protection and help the insurer from the standpoint of survival at the cost of insurer profitability. We also suggest that shadow insurance and lending to high-quality borrowing firms captured by low leverage might increase policyholder protection and insurer survival, thereby contributing to insurance stability.

KEYWORDS:

• Borrower capital
• shadow insurance
• capped call option
• life insurer

JEL CLASSIFICATION:

• G13
• G22

Acknowledgments

The authors would like to thank David Peel (the editor) and an anonymous referee for their helpful comments and suggestions. The usual disclaimer applies.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Hereafter, the terms ‘shadow insurance’ or ‘shadow banking activities’ refer to ‘shadow banking entrusted loans’ in our model.