My publications
13. "Adverse selection in tontines" (with Thorsten Moenig), The Geneva Risk and Insurance Review, [open access version]
Several recent studies have cited the theoretical work of Valdez et al. (2006) as evidence that there is less adverse selection in tontine-style products than in conventional life annuities. We argue that the modeling work and results of Valdez et al. (2006) do not unconditionally support such a claim. Conducting our own analyses structured in a similar way but focusing on the relative instead of absolute change in annuity vs. tontine investments, we find that an individual with private information about their own survival prospect can potentially adversely select against tontines at the same, or even higher levels than against annuities. Our results suggest that the investor’s relative risk aversion is the driving factor of the relative susceptibility of the two products to adverse selection.
12. "Modeling the Risk in Mortality Projections" (with Daniel Bauer), Operations Research, 70(4): 2069-2084. [working paper version]
This paper presents and applies models for the valuation and management of mortality-contingent exposures. Such exposures include insurance and pension benefits as well as novel mortality-linked securities traded in financial markets. Unlike conventional approaches to modeling mortality, we consider the stochastic evolution of mortality projections rather than realized mortality rates. Relying on a time series of age-specific mortality forecasts, we develop a set of stochastic models that—unlike conventional mortality models—capture the evolution of mortality forecasts over the past fifty years. In particular, the dynamics of our models reflect the substantial observed variability of long-term projections, and are therefore particularly well-suited for financial applications where long-term demographic uncertainty is relevant.
11. "The Efficiency of Voluntary Risk Classification in Insurance Markets" (with Keith J. Crocker), Journal of Risk and Insurance, 88: 325-350. [working paper version]
It has been established that categorical discrimination based on observable characteristics such as gender, age, or ethnicity enhances efficiency. We consider a different form of risk classification where there exists some costless yet imperfectly informative test on risk types, with the test outcome unknown to the agents ex-ante. We show that a voluntary risk classification where agents are given the option to take the test always increases efficiency compared with no risk classification. Moreover, voluntary risk classification also Pareto dominates the regime of compulsory risk classification in which all agents are required to take the test.
10. "The Economics of a Secondary Market for Variable Annuities" (with Thorsten Moenig), North American Actuarial Journal, 25: 604-630. [working paper version]
Supported under the 2018 CKER Individual Research Grant by the Society of Actuaries.
This article demonstrates that a secondary market for U.S. variable annuity policies may be immediately welfare-enhancing to all parties involved: the insurer, the original policyholder, and a third-party investor. Our model reflects relevant market frictions—here, the product’s tax benefits—that produce differing valuation perspectives for the three parties. This allows for policy transfers that benefit all parties simultaneously, including the insurance company, irrespective of the level of control that it exerts over this secondary market. We illustrate our insights first with a theoretical two-period model, followed by an empirically motivated numerical analysis. Our numerical results suggest a best-estimate total welfare gain of 2.6% of the initial investment amount under the optimal secondary-market structure.
9. "Asymmetric Information in Secondary Insurance Markets: Evidence from the Life Settlements Market" (with Daniel Bauer and Jochen Russ), Quantitative Economics, 11: 1143-1175. [working paper version]
We use data from a large US life expectancy provider to test for asymmetric information in the secondary life insurance—or life settlement—market. We compare realized lifetimes for a subsample of settled policies relative to all (settled and non-settled) policies, and find a positive settlement-survival correlation indicating the existence of informational asymmetry between policyholders and investors. Estimates of the “excess hazard” associated with settling show the effect is temporary and wears off over approximately eight years. This indicates individuals in our sample possess private information with regards to their near-term survival prospects and make use of it, which has economic consequences for this market and beyond.
8. "Hedging Longevity Risk: Does the Structure of the Financial Instrument Matter?" (with Richard D. MacMinn), North American Actuarial Journal, 25: S373-S384. [working paper version]
Longevity-linked securities can be constructed either as cash-flow hedging instruments or as value hedging instruments. This article studies the interaction between the structure of longevity-linked securities and shareholder value. Relying on a strand of literature that investigates corporate risk management decisions made in the interests of shareholders, we present a framework that compares cash-flow hedges with value hedges. Both our theoretical model and numerical experiments show that value hedging dominates cash-flow hedging in the context of management decisions being made to maximize shareholder value. This finding provides an explanation for the failure of some attempted issues of longevity risk transfer instruments and suggests efficient alternate structures.
7. "Evaluating Life Expectancy Evaluations" (with Daniel Bauer, Michael V. Fasano, and Jochen Russ), North American Actuarial Journal, 22: 198-209. [working paper version]
The quality of life expectancy estimates is one key consideration for an investor in life settlements. The predominant metric for assessing this quality is the so-called A-To-E Ratio, which relies on a comparison of the actual to the predicted number of deaths. In this article, we explain key issues with this metric: In the short run, it is subject to estimation uncertainty for small and moderately-sized portfolios; and, more critically, in the long run, it converges to 100% even if the underwriting is systematically biased. As an alternative, we propose and discuss a set of new metrics based on the Difference in (Temporary) Life Expectancies. We examine the underwriting quality of a leading US life expectancy provider based on this new methodology.
6. "Policyholder Exercise Behavior in Life Insurance: The State of Affairs" (with Daniel Bauer, Jin Gao, Thorsten Moenig, and Eric R. Ulm), North American Actuarial Journal, 21: 485-501. [working paper version]
The article presents a review of structural models of policyholder behavior in life insurance. We first discuss underlying drivers of policyholder behavior in theory and survey the implications of different models. We then turn to empirical behavior and appraise how well different drivers explain observations. The key contributions lie in the synthesis and the systematic categorization of different approaches. The article should provide a foundation for future studies, and we describe some important directions for future research in the conclusion.
5. "Lapse-and-Reentry in Variable Annuities" (with Thorsten Moenig), Journal of Risk and Insurance, 85: 911-938. [working paper version]
Winner of the 2017 Redington Prize by the Society of Actuaries Investment Section.
Section 1035 of the current U.S. tax code allows policyholders to exchange their variable annuity policy for a similar product while maintaining tax-deferred status. When the variable annuity contains a long-term guarantee, this “lapse-and-reentry” strategy allows the policyholder to potentially increase the value of the embedded guarantee. We show that for a return-of-premium death benefit guarantee this is frequently optimal, which has severe repercussions for pricing. We analyze various policy features that may help mitigate the incentive to lapse and compare them regarding the insurer's average expense payments and their posttax utility to the policyholder. We find that a ratchet-type guarantee and a state dependent fee structure best mitigate the lapse-and-reentry problem, outperforming the typical surrender schedule. Further, when accounting for proper tax treatment, the policyholder prefers a variable annuity with either of these three policy features over a comparable stock investment.
4. "Hedging Longevity Risk in Life Settlements Using Biomedical Research-Backed Obligations" (with Richard D. MacMinn), Journal of Risk and Insurance, 84: 439–458. [working paper version]
In the life settlement market, mortality risk is transferred from life insurance policyholders to third-party life settlement firms. This risk transfer occurs in conjunction with an information transfer that is relevant not only for pricing, but also for risk management. In this analysis, we compare the efficiency of two different hedging instruments in managing the mortality risk of the life settlement firm. First, we claim and then demonstrate that conventional longevity-linked securities do not perform as effectively in the secondary life market, that is, life settlement market, as in the annuity and pension markets due to the basis risk that exists between the general population and the life settlement subgroup. Second, we show that the unique risk exposure of the life settlement firm can be specifically targeted using a new instrument—the biomedical research-backed obligations. Our finding connects two seemingly independent markets and can promote the healthy development of both.
3. "A Cautionary Note on Natural Hedging of Longevity Risk" (with Daniel Bauer), North American Actuarial Journal, 18: 104-115. [working paper version]
Top three most downloaded articles in The North American Actuarial Journal in 2014.
In this article, we examine the so-called natural hedging approach for life insurers to internally manage their longevity risk exposure by adjusting their insurance portfolio. In particular, unlike the existing literature, we also consider a nonparametric mortality forecasting model that avoids the assumption that all mortality rates are driven by the same factor(s).
Our primary finding is that higher order variations in mortality rates may considerably affect the performance of natural hedging. More precisely, although results based on a parametric single factor model—in line with the existing literature—imply that almost all longevity risk can be hedged, results are far less encouraging for the nonparametric mortality model. Our finding is supported by robustness tests based on alternative mortality models.
2. "Coherent Pricing of Life Settlements Under Asymmetric Information" (with Daniel Bauer), Journal of Risk and Insurance, 80: 827-851. [working paper version]
Seminalist for 2012 FMA Annual Meeting Best Paper Award in Investments.
Although life settlements are advertised to deliver a profitable investment opportunity with a low correlation to market systematic risk, recent investigations reveal a discrepancy of expected and realized returns. While thus far this discrepancy has been attributed to the (allegedly) poor quality of the underlying life expectancy estimates, we present a different explanation of the seemingly high reported expected returns based on adverse selection. In particular, we provide a coherent pricing mechanism and pricing formulas in the presence of asymmetric information with respect to the underlying life expectancies. Therefore, our study sheds light on the nature of the “unique risks” within life settlements as recently discussed in the financial press.
1. "Applications of Forward Mortality Factor Models in Life Insurance Practice" (with Daniel Bauer), The Geneva Papers on Risk and Insurance — Issues and Practice, 36: 567-594. [working paper version]
Finalist for the 2011 Lloyd's Science of Risk Prize in Insurance operations and markets.
Two of the most important challenges for the application of stochastic mortality models in life insurance practice are their complexity and their apparent incompatibility with classical life contingencies theory, which provides the backbone of insurers’ Electronic Data Processing systems. Forward Mortality Factor Models comprise one model class that overcomes these challenges. Relying on a simple model version that originates from a semi-parametric estimation based on British population mortality data, this paper demonstrates the merits of this model class by discussing several practically important example applications. In particular, we calculate the Economic Capital for a stylised life insurer, we present a closed-form solution for the value of a Guaranteed Annuity Option, and we derive the fair option fee for a Guaranteed Minimum Income Benefit within a Variable Annuity contract. Our numerical results illustrate the economic significance of systematic mortality risk.