Consequences of the Reduction of Interest Rates on Insurance

In this paper we try to assess the impact of various policy changes on the ability of the insurance industry to preserve or increase the shareholders' value. As a proxy of shareholders value, we measure the sensitivity of ROE (Return On Equities) to three main variables i.e.: (1) Different asset allocation strategies (low and high risk investment of segregated funds). (2) Cost cutting policy (fixed and distribution costs). (3) Different floor options (minimum guaranteed from 4 to 0 percent). The ROE sensitivity is estimated through a Monte Carlo simulation, where we assume that the portfolio is invested in three total return market indices. The typical portfolio in the simulations is structured as follows: 5-year treasury bonds, 5-year corporate bonds, equity; and we neglect foreign exchange risk. A 10-year single premium policy, with a reimbursement only at maturity is considered. We show that a high minimum guaranteed return and the actual prevailing financial market conditions, aggressive investment policies (stocks in excess of 10–15 percent of total assets) are likely to destroy shareholders' value. Our results indicate that reduction of minimum guaranteed rates and cost cutting are imperative, and an appropriate combination of the two appears to be the best solution. The Geneva Papers on Risk and Insurance (2000) 25, 63–77. doi:10.1111/1468-0440.00049