A simple model of financial grey rhino under insurer capital regulation

ABSTRACT

This paper develops a contingent claim model to examine how capital regulation affects an insurer’s optimal guaranteed rate and survival probability when the investment-oriented/life insurance policy-oriented financial grey rhino is complemented. The investment-oriented grey rhino effect increases the policies at an increased guaranteed rate (and thus a decreased interest margin) and further decreases the insurer’s survival probability. The policy-oriented grey rhino effect decreases the guaranteed rate and further decreases the survival probability. Stringent capital regulation enhances both the guaranteed rate and the insurer’s survival, thereby contributing to insurance stability. Both the enhanced effects become more significant when either the increased investment-oriented or policy-oriented financial grey rhino effect is considered, in particular, in a down-and-out call option framework model.

KEYWORDS:

• Financial grey rhino
• guaranteed rate
• capital regulation
• insurer survival

JEL CLASSIFICATION:

• G21
• G28

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ We argue that the five causes in EIOPA (2018) and the two grey rhino effects in our model are not mutually exclusive.

² In our model, it is strong to assume that the reduced return due to the grey rhino effect equals to the increased volatility and both the impacts insurer in the value assessment simultaneously. However, adding this assumption is expected to be not alter the qualitative results derived from our model.

³ The author appreciates the comment from the reviewer. Indeed, the results derived from the model ignore the case $b=0$. However, the purpose of the model to mention this case is only for a possible case of the formula of Black and Scholes (1973), which applies to the model we have developed.