Combined actuarial and financial valuation of hybrid insurance liabilities

This joint PhD project is based at The University of Melbourne with a minimum 12 month stay at KU Leuven

Project title:  VALERIA: Valuation and Advanced Learning methods for Emerging, global Risks In Actuarial science

Project description
The 21st century faces emerging risks, such as climate change and cyber risk, as well as new versions of long-standing risks, such as longevity and pandemics, which often have a substantial systematic character. The systematic nature, arising from the interconnectedness between members in a portfolio of such risks, implies that the traditional insurance technique – pooling the individual risks of the members – cannot or can only partially reduce the risk of the portfolio and hence, is not a sufficient risk management strategy.

This project focuses on new valuation and risk management techniques for managing portfolios with systematic risks. In a first step, the concept of insurance securitization, where insurance risks are transferred to financial markets by trading insurance-linked securities, will be investigated, with the focus on index-based securities. Such securities exhibit transparency and are potentially highly liquid, but may face a mismatch between the financial hedge and the risks underlying the insurance portfolio.

The goal is to measure how effectively index-based securities can transfer risks specific to an insurer and to apply an effectiveness measure to the valuation of insurance liabilities. In a second step, we investigate the integration of financial market-consistent valuation and classical actuarial pooling techniques. Such an integrated approach is needed to correctly value risks in insurance portfolios with an important systematic risk component which is traded (or of which a proxy is traded) in financial markets. The goal is to develop a better and more appropriate risk management framework, making society more resilient to systematic insurance risks.

While hedging financial risks in insurance claims has been the subject of research in detail, setting up and using capital market products to hedge actuarial risks, such as longevity and climate change, is still in full development. Insurance risks are managed traditionally by using pooling techniques and reinsurance. More recently, both insurers and reinsurers increasingly tap into the capital market and transfer a portion of their risks to investors through securitization of insurance risks.

Insurance-linked securities often only provide a partial hedge for insurance risks, partially due to basis risks. The insurance risk market has significant implications on the pricing and valuation of insurance claims. If the insurance risk market is liquid, part of the risk underlying an insurance portfolio can be readily transferred to deeper pockets with the risk transfer cost used as the value of the hedgeable part of the insurance liability. A best estimate and a risk margin need to be held for the remaining risk in the unhedgeable part of the insurance liability.

The project will be complemented by the project on The actuarial valuation of insurable risks in a changing risk landscape and the collaboration will ensure a successful completion of the project.

Supervision team:

Principal Investigators (PIs)

Dr Rui Zhou (The University of Melbourne)
Professor Dr Katrien Antonio (KU Leuven)

Co-Principal Investigators (co-PIs)

Professor Benjamin Avanzi (The University of Melbourne)
Professor Dr Jan Dhaene (KU Leuven)