infonet-economy

Throughout the last decade, the European Union (EU) has been working on new, risk-based capital standards for insurance companies termed Solvency II. The first part of this dissertation contains two papers that focus on the market risk module of Solvency II with the aim to provide additional impulses to insurers, asset managers, and regulators in the ongoing discussion of the new standards. In the paper "Portfolio Optimization Under Solvency II: Implicit Constraints Imposed by the Market Risk Standard Formula", the implications of the standard formula on a life insurance company's asset allocation are analyzed. The results show that the standard formula suffers from several severe shortcomings that interfere with economically sensible asset management decisions. Therefore, the introduction of Solvency II in its current form is likely to have an adverse impact on certain parts of the European insurance sector.

The paper "Solvency II's Market Risk Standard Formula: How Credible is the Proclaimed Ruin Probability?" goes a step further and assesses the credibility of the ruin probability allegedly associated with the market risk standard formula. The analysis reveals that most admissible portfolios were found to be associated with ruin probabilities clearly above the regulator's target. On the other hand, feasible asset allocations are associated with ruin probabilities below the target, implying excessive capital charges under the standard formula. Therefore, since a large fraction of small to medium-sized companies can be assumed to resort to the standard formula, the introduction of Solvency II will likely lead to a lot more ambiguity about the insolvency risk of the insurance sector than currently expected.

The second part of this dissertation is devoted to term life insurance contracts in the German market. Term life insurance is one of the oldest and most successful insurance products offered to date. Despite the size and importance of this market in most developed economies, however, the customers' willingness to pay (WTP) for such policies is still not well understood. In this respect, the paper "On Consumer Preferences and the Willingness to Pay for Term Life Insurance" comprises a choice-based conjoint analysis for such products with a sample of 2,017 German consumers. For the average respondent, brand, critical illness cover, and medical underwriting turn out to be the most important nonprice attributes. Hence, if a policy comprises their favored specifications, customers accept substantial markups in the monthly premium. However, preferences vary considerably among the respondents. While some of the latter would pay relatively high monthly premiums, a large fraction exhibits no WTP for term life policies at all, presumably due to the absence of a need for mortality risk coverage. The results further illustrate that a utility-oriented product optimization is well-suited to gain market shares, avoid competitive price pressure, and access additional profit potential. Finally, estimated demand sensitivities and a set of cost assumptions show that the traditional pricing approaches based on cost considerations are clearly inferior to the preference-based methodology employed in this research paper.

The dissertation is completed by the article "Identification of Customer Groups in the German Term Life Market: A Benefit Segmentation". Given the remarkable disagreement among the 2,017 respondents on the attribute levels as indicated by the individual part-worth utility profiles, this paper provides an approach how to segment a market based on the benefits sought. The results show that besides a pure price segment, a large number of customers focus both on the insurance brand and the insurer's underwriting policy. Moreover, there is evidence for a third market segment comprising undecided consumers with preference structures in line with the average respondent from the whole sample. Hence, term life providers equipped with this preference information are able to develop segment-specific products that allow them to maintain and expand their current position in the German market.