IDEAS home Printed from https://ideas.repec.org/a/bpj/apjrin/v14y2020i2p30n1.html
   My bibliography  Save this article

Currency Uncertainty, Interest Guarantee, and Risk-Based Premiums in Life Insurance Guaranty Schemes

Author

Listed:
  • Chang Shih-Chieh Bill

    (Department of Risk and Insurance, National Chengchi University, Taipei, Taiwan)

  • Lee Yen-Kuan

    (Department of Risk and Insurance, National Chengchi University, Taipei, Taiwan)

Abstract

This paper investigates risk-based premiums in ex-ante insurance guaranty schemes. Exchange rate risk is incorporated into the asset portfolio to reflect the growing practice of life insurers taking offshore risks for yield enhancement. The closed-form solutions of the risk-based premium charged by the insurance guaranty fund are derived. Our premium rating includes currency mismatches between assets and liabilities, and the effects of early closure, capital forbearance, and grace periods are fully explored. First, we discover that the insurance guaranty fund premium is underestimated if currency fluctuation uncertainty is overlooked. Second, the premium is higher under regulatory forbearance than it is under the Merton stock put option, which implies that the cost is substantial. Finally, we note that the premium increases with higher financial leverage and greater foreign exposure in the asset portfolio. The results of our analysis provide further insight for regulators to implement regulatory policies and insurance guaranty schemes.

Suggested Citation

  • Chang Shih-Chieh Bill & Lee Yen-Kuan, 2020. "Currency Uncertainty, Interest Guarantee, and Risk-Based Premiums in Life Insurance Guaranty Schemes," Asia-Pacific Journal of Risk and Insurance, De Gruyter, vol. 14(2), pages 1-30, July.
    • Handle: RePEc:bpj:apjrin:v:14:y:2020:i:2:p:30:n:1
    DOI: 10.1515/apjri-2019-0035
    as

    Download full text from publisher

    File URL: https://doi.org/10.1515/apjri-2019-0035
    Download Restriction: For access to full text, subscription to the journal or payment for the individual article is required.
    File URL: https://libkey.io/10.1515/apjri-2019-0035?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
    2. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(4), pages 627-627, November.
    3. Duan, Jin-Chuan & Yu, Min-Teh, 2005. "Fair insurance guaranty premia in the presence of risk-based capital regulations, stochastic interest rate and catastrophe risk," Journal of Banking & Finance, Elsevier, vol. 29(10), pages 2435-2454, October.
    4. repec:bla:jfinan:v:43:y:1988:i:4:p:823-39 is not listed on IDEAS
    5. Duan, Jin-Chuan & Yu, Min-Teh, 1999. "Capital standard, forbearance and deposit insurance pricing under GARCH," Journal of Banking & Finance, Elsevier, vol. 23(11), pages 1691-1706, November.
    6. Chen, An & Suchanecki, Michael, 2007. "Default risk, bankruptcy procedures and the market value of life insurance liabilities," Insurance: Mathematics and Economics, Elsevier, vol. 40(2), pages 231-255, March.
    7. Han, Li-Ming & Lai, Gene C. & Witt, Robert C., 1997. "A financial-economic evaluation of insurance guaranty fund system: An agency cost perspective," Journal of Banking & Finance, Elsevier, vol. 21(8), pages 1107-1129, August.
    8. Hwang, Dar-Yeh & Shie, Fu-Shuen & Wang, Kehluh & Lin, Jung-Chu, 2009. "The pricing of deposit insurance considering bankruptcy costs and closure policies," Journal of Banking & Finance, Elsevier, vol. 33(10), pages 1909-1919, October.
    9. Duan, Jin-Chuan & Simonato, Jean-Guy, 2002. "Maximum likelihood estimation of deposit insurance value with interest rate risk," Journal of Empirical Finance, Elsevier, vol. 9(1), pages 109-132, January.
    10. Jin-Chuan, Duan & Moreau, Arthur F. & Sealey, C. W., 1995. "Deposit insurance and bank interest rate risk: Pricing and regulatory implications," Journal of Banking & Finance, Elsevier, vol. 19(6), pages 1091-1108, September.
    11. Ronn, Ehud I & Verma, Avinash K, 1986. "Pricing Risk-Adjusted Deposit Insurance: An Option-Based Model," Journal of Finance, American Finance Association, vol. 41(4), pages 871-895, September.
    12. Ya-Wen Hwang & Shih-Chieh Chang & Yang-Che Wu, 2015. "Capital Forbearance, Ex Ante Life Insurance Guaranty Schemes, and Interest Rate Uncertainty," North American Actuarial Journal, Taylor & Francis Journals, vol. 19(2), pages 94-115, April.
    13. Boulier, Jean-Francois & Huang, ShaoJuan & Taillard, Gregory, 2001. "Optimal management under stochastic interest rates: the case of a protected defined contribution pension fund," Insurance: Mathematics and Economics, Elsevier, vol. 28(2), pages 173-189, April.
    14. Shang-Yin Yang & Ya-Wen Hwang & Shih-Chieh Chang, 2012. "The Bankruptcy Cost of the Life Insurance Industry Under Regulatory Forbearance," North American Actuarial Journal, Taylor & Francis Journals, vol. 16(4), pages 513-523.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Duan, Jin-Chuan & Yu, Min-Teh, 2005. "Fair insurance guaranty premia in the presence of risk-based capital regulations, stochastic interest rate and catastrophe risk," Journal of Banking & Finance, Elsevier, vol. 29(10), pages 2435-2454, October.
    2. Chia-Chien Chang & Min-Teh Yu, 2017. "Valuing Vulnerable Mortgage Insurance Under Capital Forbearance," The Journal of Real Estate Finance and Economics, Springer, vol. 54(4), pages 558-578, May.
    3. Chiang, Shu Ling & Tsai, Ming Shann, 2020. "The valuation of deposit insurance allowing for the interest rate spread and early-bankruptcy risk," The Quarterly Review of Economics and Finance, Elsevier, vol. 76(C), pages 345-356.
    4. Hwei-Lin Chuang & Shih-Cheng Lee & Yi-Chun Lin & Min-Teh Yu, 2009. "Estimating the cost of deposit insurance with stochastic interest rates: the case of Taiwan," Quantitative Finance, Taylor & Francis Journals, vol. 9(1), pages 1-8.
    5. Hangsuck Lee & Seongjoo Song & Gaeun Lee, 2023. "Insurance guaranty premiums and exchange options," Mathematics and Financial Economics, Springer, volume 17, number 3, December.
    6. Fernández-Aguado, Pilar Gómez & Martínez, Eduardo Trigo & Ruíz, Rafael Moreno & Ureña, Antonio Partal, 2022. "Evaluation of European Deposit Insurance Scheme funding based on risk analysis," International Review of Economics & Finance, Elsevier, vol. 78(C), pages 234-247.
    7. Chia-Chien Chang & Min-Teh Yu, 2018. "Bank Contingent Capital: Valuation and the Role of Market Discipline," Journal of Financial Services Research, Springer;Western Finance Association, vol. 54(1), pages 49-80, August.
    8. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    9. Lee, Jin-Ping & Yu, Min-Teh, 2007. "Valuation of catastrophe reinsurance with catastrophe bonds," Insurance: Mathematics and Economics, Elsevier, vol. 41(2), pages 264-278, September.
    10. Lo, Chien-Ling & Lee, Jin-Ping & Yu, Min-Teh, 2013. "Valuation of insurers’ contingent capital with counterparty risk and price endogeneity," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 5025-5035.
    11. Liu, Hailong & Li, Rui & Yuan, Jinjian, 2018. "Deposit insurance pricing under GARCH," Finance Research Letters, Elsevier, vol. 26(C), pages 242-249.
    12. Duan, J. & Sealey, C. W. & Yan, Y., 1999. "Managing banks' duration gaps when interest rates are stochastic and equity has limited liability," International Review of Economics & Finance, Elsevier, vol. 8(3), pages 253-265, September.
    13. Duan, Jin-Chuan & Simonato, Jean-Guy, 2002. "Maximum likelihood estimation of deposit insurance value with interest rate risk," Journal of Empirical Finance, Elsevier, vol. 9(1), pages 109-132, January.
    14. Castañeda, Pablo & Devoto, Benjamín, 2016. "On the structural estimation of an optimal portfolio rule," Finance Research Letters, Elsevier, vol. 16(C), pages 290-300.
    15. Nicole Branger & An Chen & Antje Mahayni & Thai Nguyen, 2023. "Optimal collective investment: an analysis of individual welfare," Mathematics and Financial Economics, Springer, volume 17, number 5, December.
    16. Wang, Guanying & Wang, Xingchun & Shao, Xinjian, 2022. "Exchange options for catastrophe risk management," The North American Journal of Economics and Finance, Elsevier, vol. 59(C).
    17. Pennacchi, George G., 2005. "Risk-based capital standards, deposit insurance, and procyclicality," Journal of Financial Intermediation, Elsevier, vol. 14(4), pages 432-465, October.
    18. Burnecki, Krzysztof & Giuricich, Mario Nicoló & Palmowski, Zbigniew, 2019. "Valuation of contingent convertible catastrophe bonds — The case for equity conversion," Insurance: Mathematics and Economics, Elsevier, vol. 88(C), pages 238-254.
    19. Yumo Zhang, 2023. "Utility maximization in a stochastic affine interest rate and CIR risk premium framework: a BSDE approach," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 46(1), pages 97-128, June.
    20. Carolyn W. Chang & Jack S. K. Chang & Min‐Teh Yu & Yang Zhao, 2020. "Portfolio optimization in the catastrophe space," European Financial Management, European Financial Management Association, vol. 26(5), pages 1414-1448, November.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bpj:apjrin:v:14:y:2020:i:2:p:30:n:1. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Peter Golla (email available below). General contact details of provider: https://www.degruyter.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.