Modelling of dynamic policyholder behaviour and considering associated management action plans are recently regarded as an essential part of the life actuarial science. It is also required in Solvency II framework to consider dynamic policyholder behaviour in the calculation of the SCR and also in technical provisions. In this note, we study these hot topics briefly.

Dynamic policyholder behaviour

Dynamic policyholder behaviour is the modelling of assumptions about the policyholder's decision in the future. Their behaviour may differ depending on one or more factors, such as changes in market or any change in companies bonus rate. In order to face the risk of surrender of many policyholders the insurer should take actions, i.e., management actions; such as investment strategies and setting bonus or profit sharing. Companies should examine the sensitivity of their solvency to dynamic policyholder behaviour to determine their exposure to these kind of risks and their consequences.

Related insurance risks

Longevity:  It happens when the policyholder lives longer than what was predicted. Its impact on the insurer can be longer payment stream and increase in the best estimate of the company.

We categorize the longevity risk as follows: 

  • Systematic Risk: incorrect assumption in mortality rate, that can not be diversified away, only can be managed or quantified.
  • Specific Risk: normal volatility that arises around the basic Best estimate assumptions and can be reduced by increasing the insurance population.

Surrender: Voluntary pre-mature termination of the contract by the insurer, with or without payment of surrender value. It may happen in two cases:

  •  Change of insurance institution,
  •  Policyholder refuses to pay the premiums.

Surrender Behaviour: The policyholder behaviour can be classified in the following types:

  • Rational policyholder behaviour in which the policyholder terminates the contract if: Pension capital \( \gg \) Guarantee reserve. In other words, it is not beneficial for the policyholder to pay a guarantee fee and the rational behavior is to move the capital to another contract with lower fees. 
  • Irrational policyholder behaviour, e.g, health problems or personal circumstances, which is more difficult to take into consideration in the modeling of policyholder behavior.

Insurers may consider the level of rationality as a parameter which takes values between 0 and 1 (1 for fully rational behaviour and 0 for neutral decision making), among the other uncertainty parameters in their analysis.

Surrender Risk: The value of resources and liabilities of the insurer may change in case that more surrender happens than what was originally predicted in valuation. This kind of risk is usually called surrender risk. Surrender risk might have a big impact on insurance companies liquidity, therefore they should be prepared to stress test the liquidity reserves if mass surrenders occur.

Management actions

As we stated before, in the presence of large-scale changes in policyholder behaviour, the insurer needs to consider management actions in order to prevent major risk exposure. We have already discussed the management actions in detail in our previous article series, thus we just review the subject very briefly in this note (See here for further reading).

Management actions stated in Solvency II refers to dynamic portfolio actions with the aim to reduce risk exposure of an insurance company. More precisely, the modelling of the management behaviour in the future, in reaction to undesirable situations is called management actions (or management rules). We can classify these rules into two different categories:

Direct Actions, such as:

  • Adjustment of profit share/bonus levels
  • Changes in charges

  • Management of expense levels

Indirect actions, such as:

  • Investment strategy
  • Reinsurance
  • Dynamic hedging

We point out that it is easier to work with management actions instead of dynamic policyholder behaviour due to the possible irrational actions of many of the policyholders.