Deflation Risk and Implications for Life Insurers

Life insurers are exposed to deflation risk: falling prices could lead to insufficient investment returns, and inflation-indexed protections could make insurers vulnerable to deflation. In this spirit, this paper proposes a market-based methodology for measuring deflation risk based on a discrete fr...

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Bibliographic Details
Published inRisks (Basel) Vol. 4; no. 4; p. 46
Main Author Begin, Jean-François
Format Journal Article
LanguageEnglish
Published Basel MDPI AG 01.12.2016
Subjects
Deflation
deflation risk
Economic models
Inflation
inflation caps and floors
Life insurance
Risk
risk management
unscented Kalman filter
United States > US
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Summary:Life insurers are exposed to deflation risk: falling prices could lead to insufficient investment returns, and inflation-indexed protections could make insurers vulnerable to deflation. In this spirit, this paper proposes a market-based methodology for measuring deflation risk based on a discrete framework: the latter accounts for the real interest rate, the inflation index level, its conditional variance, and the expected inflation rate. US inflation data are then used to estimate the model and show the importance of deflation risk. Specifically, the distribution of a fictitious life insurer’s future payments is investigated. We find that the proposed inflation model yields higher risk measures than the ones obtained using competing models, stressing the need for dynamic and market-consistent inflation modelling in the life insurance industry.
ISSN:2227-9091
2227-9091
DOI:10.3390/risks4040046