New Challenges in Banking and Finance by Nesrin ÖZATAÇ & Korhan K. GÖKMENOGLU

Author:Nesrin ÖZATAÇ & Korhan K. GÖKMENOGLU
Language: eng
Format: epub
Publisher: Springer International Publishing, Cham

In summary, goverments and life insurance companies didn’t notice the potential financial risk of longevity till twentieth century. But all the researches that have done in last 15 years created a significant awareness on this issue and the developments on this risk type prompted people to hedging longevity risk.

Nowadays, longevity risk is at the forefront in developed countries. It should not be forgotten that if longevity risk is not taken into account in financial calculations by companies that deal with human life, the possibility of unexpected costs will rise and companies can come face to face with extra payments which they haven’t predicted. Also, this means serious financial trouble for the related markets. The same scenario is expected for developing countries with delay.

Longevity risk and Solvency II are closely related to each other. Solvency is the affordability of liabilities for financial institutions. For being solvent means that there is enough or more assests for liabilities (Ferrouhi and Mohammed 2014, p.233). Otherwise, companies can have difficulty in affording their obligations. According to Internaitonal Association of Insurance Supervisors (IAIS), a company is solvent if it is able to afford its liabilities under most circumstances at any time (IAIS 2000, p.6). Solvency II has important impacts on pricing, reserve funds, capital and insurance operations for annual payments (O’Sullivan 2010, p.15). Solvency Capital Requirement (SCR) can be calculated in two ways. Companies can evaluate their risk profile using an internal model or can use standard modules which are prepared for this calculations.

In this research, capital requirement and pricing longevity risk are calculated under Solvency II conditions. Basically, total risk should be divided into risk types and all risk types should be multiplied with their own risk factors. According to Solvency II, life insurance companies should also calculate risk margin (RM) as well as SCR (Meyricke and Sherries 2013, p.7). Also, European Insurance and Occupational Pensions Authority (EIOPA) had advised to use cost of capital as %6 in RM calculations (EIOPA 2012, p.85).

Using financial derivative instruments is a useful way in hedging longevity risk and I chose swap as a financial derivative instruments. Swap is widely used for risk management for long years. When people live more than it had expected, insurance companies will come face to face with floating mortality rates. This instability will bring to the life insurance companies financial surcharge. The researches on longevity risk has shown that this type of instruments should be improved for hedging. Also, goverment support is essential for economic balance in this market (OECD 2014, p.12).

Longevity risk is well known especially for last 15 years and guarding against this risk is also getting important. So that, there are many financial transactions per year and this transactions bring profit to its user. For example, in 2015 there was a swap agreement between Axa insurance in England and Reinsurance Group of America (RGA) and is priced at €2.8bn. This company is the 50th company in England that made longevity swap transaction. Hymans Robertson indicated that this longevity swap trend will continue in financial markets.

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