Applications of forward mortality factor models in life insurance practice

Abstract

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. © 2011 The International Association for the Study of Insurance Economics.