Rising interest rates, lapse risk, and the stability of life insurers

These slides examine the interest rate sensitivity of a life insurer's liquidity and solvency - with particular focus on an interest rate rise. We model the economic (market-consistent value) balance sheet of an average German life insurer subject to European Solvency II regulation. To capture portfolio and long-term effects, we explicitly incorporate an existing back book of historically sold policies and an existing asset allocation calibrated by empirical data. Our results show that a sharp increase in interest rates results in a substantial liquidity need of up to 20% of the insurer's initial assets, potentially resulting in fire sales and adverse spillovers to financial markets. This liquidity dry-up is accompanied by a deteriorating solvency, which is likely to trigger regulatory actions. We explicitly describe the mechanisms affecting the insurer's liquidity and solvency. Thus, our findings have important implications for the design of solvency and resolution regulation.