The linkage between life insurer spread behaviour and credit swap transaction: policyholder protection analysis

ABSTRACT

The paper develops a contingent claim model to evaluate the equity of a life insurer when the insurer could act as a protection buyer or a protection seller in a credit swap transaction market. The investment market and the life insurance market faced by the insurer are assumed to be imperfectly competitive in order to capture the insurer’s asset-leading or liability-reducing spread behaviour. This paper complements the insurance literature by analysing how the effects of credit swap transactions on insurer spread behaviour and policyholder protection, and how they might differ across various degrees of capital regulation, premature default risk, and profit-sharing participation. Our findings offer some useful insights for achieving the stability of the insurance system.

KEYWORDS:

• Insurer spread behaviour
• profit-sharing policy
• credit swap transaction
• policyholder protection

JEL CLASSIFICATION:

• G13
• G22

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Eckert, Gatzert, and Martin (2016) investigate that the consideration of credit risk associated with bonds has a significant impact on the fair valuation and risk assessment in the context of participating life insurance policies. In this case, we argue that the life insurer may have an incentive to conduct hedging of its asset portfolio.

² Hereafter, the term ‘swap transactions’ refers to ‘credit swap transaction’ or ‘total return swap transactions’.

³ Here, we assume a zero fee for arranging the transaction by the intermediary institution for the sake of simplicity.

⁴ Briys and de Varenne (1994) employ such the profit-sharing policy with exactly this setting.

⁵ The formula of a European down-and-out call option generally includes a term, the rebate paid to the life insurance company’s shareholders if the option reaches its barrier. In our model, we assume a zero rebate upon failure. Brockman and Turtle (2003) also adopt this assumption for simplicity.:

⁶ We follow Brockman and Turtle (2003) and consider only the case of a constant barrier with the condition of $0<h<1$.

⁷ Episcopos (2008) also employs this formula to value a bank’s liability where the term $\delta DOC(aV,Z)$ vanishes.:

⁸ In Briys and de Varenne (1994), the equilibrium condition when the life insurance policy market is perfectly competitive gives either the guaranteed rate or the participation level as the equilibrating variable. This demonstrates a nonsimultaneous determination of guarantee and participation in the life insurance policy.

Additional information

Funding

This work was supported by the National Natural Science Foundation of China under Grant 71603217.