Scandinavian Working Papers in Business Administration

Finance Working Papers,
University of Aarhus, Aarhus School of Business, Department of Business Studies

No 01-4: Life Insurance Liabilities at Market Value.

Anders Grosen () and Peter Løchte Jørgensen
Additional contact information
Anders Grosen: Department of Finance, Aarhus School of Business, Postal: Fuglesangs Allé 4, 8210 Aarhus V, Denmark
Peter Løchte Jørgensen: Department of Management, Postal: University of Aarhus, University Park 350, DK - 8000 Aarhus C, Denmark

Abstract: This paper takes a contingent claim approach to the market valuation of equity and liabilities in life insurance companies. A model is presented which explicitly takes into account the facts that the holders of life insurance contracts (LICs) have the first claim on the company’s assets whereas equityholders have limited liability, that interest rate guarantees are common elements of LICs, and that LICs according to the so-called contribution principle are entitled to receive a fair share of any investment surplus. Furthermore, a regulatory mechanism in the form of an intervention rule is built into the model. This mechanism is shown to significantly reduce the insolvency risk of the issued contracts and it implies that the various claims on the company’s assets become more exotic and obtain barrier option properties. Closed valuation formulas are nevertheless derived. Finally, some representative numerical examples illustrate how the model can be used to establish the set of initially fair contracts and to determine the market values of contracts after their inception.

Keywords: Life insurance

43 pages, May 1, 2001

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