The least squares Monte Carlo method has become a standard approach in the insurance and financial industries for evaluating a company’s exposure to market risk. However, the non-linear regression of simulated responses on risk factors poses a challenge in this procedure. This article presents a novel approach to address this issue by employing an a-priori segmentation of responses. Using a K-means algorithm, we identify clusters of responses that are then locally regressed on their corresponding risk factors. The global regression function is obtained by combining the local models with logistic regression. We demonstrate the effectiveness of the proposed local least squares Monte Carlo method through two case studies. The first case study investigates butterfly and bull trap options within a Heston stochastic volatility model, while the second case study examines the exposure to risks in a participating life insurance scenario.

Due to the presence of reporting and settlement delay, claim data sets collected by non-life insurance companies are typically incomplete, facing right censored claim count and claim severity observations. Current practice in non-life insurance pricing tackles these right censored data via a two-step procedure. First, best estimates are computed for the number of claims that occurred in past exposure periods and the ultimate claim severities, using the incomplete, historical claim data. Second, pricing actuaries build predictive models to estimate technical, pure premiums for new contracts by treating these best estimates as actual observed outcomes, hereby neglecting their inherent uncertainty. We propose an alternative approach that brings valuable insights for both non-life pricing and reserving. As such, we effectively bridge these two key actuarial tasks that have traditionally been discussed in silos. Hereto, we develop a granular occurrence and development model for non-life claims that tackles reserving and at the same time resolves the inconsistency in traditional pricing techniques between actual observations and imputed best estimates. We illustrate our proposed model on an insurance as well as a reinsurance portfolio. The advantages of our proposed strategy are most compelling in the reinsurance illustration where large uncertainties in the best estimates originate from long reporting and settlement delays, low claim frequencies and heavy (even extreme) claim sizes.

Modeling and forecasting of mortality rates are closely related to a wide range of actuarial practices, such as the designing of pension schemes. To improve the forecasting accuracy, age coherence is incorporated in many recent mortality models, which suggests that the long-term forecasts will not diverge infinitely among age groups. Despite their usefulness, misspecification is likely to occur for individual mortality models when applied in empirical studies. The reliableness and accuracy of forecast rates are therefore negatively affected. In this study, an ensemble averaging or model averaging (MA) approach is proposed, which adopts age-specific weights and asymptotically achieves age coherence in mortality forecasting. The ensemble space contains both newly developed age-coherent and classic age-incoherent models to achieve the diversity. To realize the asymptotic age coherence, consider parameter errors, and avoid overfitting, the proposed method minimizes the variance of out-of-sample forecasting errors, with a uniquely designed coherent penalty and smoothness penalty. Our empirical data set include ten European countries with mortality rates of 0–100 age groups and spanning 1950–2016. The outstanding performance of MA is presented using the empirical sample for mortality forecasting. This finding robustly holds in a range of sensitivity analyses. A case study based on the Italian population is finally conducted to demonstrate the improved forecasting efficiency of MA and the validity of the proposed estimation of weights, as well as its usefulness in actuarial applications such as the annuity pricing.

We study a fully funded, collective defined contribution (DC) pension system with multiple overlapping generations. We investigate whether the welfare of participants can be improved by intergenerational risk sharing (IRS) implemented with a realistic investment strategy (e.g., no borrowing) and without an outside entity (e.g., shareholders) that helps finance the pension fund. To implement IRS, the pension system uses an automatic adjustment rule for the indexation of individual accounts, which adapts to the notional funding ratio of the pension system. The pension system has two parameters that determine the investment strategy and the strength of the adjustment rule, which are optimized by expected utility maximization using Bayesian optimization. The volatility of the retirement benefits and that of the funding ratio are analyzed, and it is shown that the trade-off between them can be controlled by the optimal adjustment parameter to attain IRS. Compared with the optimal individual DC benchmark using the life cycle strategy, the studied pension system with IRS is shown to improve the welfare of risk-averse participants, when the financial market is volatile.

We focus on modelling categorical features and improving predictive power of neural networks with mixed categorical and numerical features in supervised learning tasks. The goal of this paper is to challenge the current dominant approach in actuarial data science with a new architecture of a neural network and a new training algorithm. The key proposal is to use a joint embedding for all categorical features, instead of separate entity embeddings, to determine the numerical representation of the categorical features which is fed, together with all other numerical features, into hidden layers of a neural network with a target response. In addition, we postulate that we should initialize the numerical representation of the categorical features and other parameters of the hidden layers of the neural network with parameters trained with (denoising) autoencoders in unsupervised learning tasks, instead of using random initialization of parameters. Since autoencoders for categorical data play an important role in this research, they are investigated in more depth in the paper. We illustrate our ideas with experiments on a real data set with claim numbers, and we demonstrate that we can achieve a higher predictive power of the network.

We consider a premium control problem in discrete time, formulated in terms of a Markov decision process. In a simplified setting, the optimal premium rule can be derived with dynamic programming methods. However, these classical methods are not feasible in a more realistic setting due to the dimension of the state space and lack of explicit expressions for transition probabilities. We explore reinforcement learning techniques, using function approximation, to solve the premium control problem for realistic stochastic models. We illustrate the appropriateness of the approximate optimal premium rule compared with the true optimal premium rule in a simplified setting and further demonstrate that the approximate optimal premium rule outperforms benchmark rules in more realistic settings where classical approaches fail.

A target benefit plan (TBP) is a collective defined contribution (DC) plan that is growing in popularity in Canada. Similar to DC plans, TBPs have fixed contribution rates, but they also implement pooling of longevity and investment risk. In this paper, we formulate a multi-period model that incorporates two sources of risk – asset risk and labor income risk for active members. We present an optimal investment and retirement benefits schedule for TBP members with a fixed contribution rate. Using Australian data from 1965 to 2018, we evaluate the performance of the optimal TBP scheme and compare it to the optimal DC scheme. By adopting the benefit–investment strategy derived in this paper, we demonstrate the stability of benefit distribution over time for a TBP scheme in this stochastic formulation. To outperform the DC scheme’s benefit payment, careful consideration shall be given to the benefit target in the TBP scheme. A high target may not be achievable, while a low target can impede the accumulation momentum of the fund’s wealth in its early stages. Moreover, a TBP fund’s investment strategy is primarily influenced by the wealth target, with more aggressive investments in risky assets as the wealth target increases. This analysis may shed light on the possible improvements to retirement planning in Australia. Although the results are sensitive to the choice of model parameters, overall, the proposed TBP promotes system stability in various scenarios.

Longevity risk is putting more and more financial pressure on governments and pension plans worldwide due to pensioners’ increasing trend of life expectancy and the growing numbers of people reaching retirement age. Lee and Carter (1992, Journal of the American Statistical Association, 87(419), 659–671.) applied a one-factor dynamic factor model to forecast the trend of mortality improvement, and the model has since become the field’s workhorse. It is, however, well known that their model is subject to the limitation of overlooking cross-dependence between different age groups. We introduce Factor-Augmented Vector Autoregressive (FAVAR) models to the mortality modelling literature. The model, obtained by adding an unobserved factor process to a Vector Autoregressive (VAR) process, nests VAR and Lee–Carter models as special cases and inherits both frameworks’ advantages. A Bayesian estimation approach, adapted from the Minnesota prior, is proposed. The empirical application to the US and French mortality data demonstrates our proposed method’s efficacy in both in-sample and out-of-sample performance.

We study the time-consistent investment and contribution policies in a defined benefit stochastic pension fund where the manager discounts the instantaneous utility over a finite planning horizon and the final function at constant but different instantaneous rates of time preference. This difference, which can be motivated for some uncertainties affecting payoffs at the end of the planning horizon, will induce a variable bias between the relative valuation of the final function and the previous payoffs and will lead the manager to show time-inconsistent preferences. Both the benefits and the contribution rate are proportional to the total wage of the workers that we suppose is stochastic. The aim is to maximize a CRRA utility function of the net benefit relative to salary in a bounded horizon and to maximize a CRRA final utility of the fund level relative to the salary. The problem is solved by means of dynamic programming techniques, and main results are illustrated numerically.

The tail index is an important parameter that measures how extreme events occur. In many practical cases, this tail index depends on covariates. In this paper,we assume that it takes a finite number of values over a partition of the covariate space. This article proposes a tail index partition-based rules extraction method that is able to construct estimates of the partition subsets and estimates of the tail index values. The method combines two steps: first an additive tree ensemble based on the Gamma deviance is fitted, and second a hierarchical clustering with spatial constraints is used to estimate the subsets of the partition. We also propose a global tree surrogate model to approximate the partition-based rules while providing an explainable model from the initial covariates. Our procedure is illustrated on simulated data. A real case study on wind property damages caused by tornadoes is finally presented.

A variable annuity is a modern life insurance product that offers its policyholders participation in investment with various guarantees. To address the computational challenge of valuing large portfolios of variable annuity contracts, several data mining frameworks based on statistical learning have been proposed in the past decade. Existing methods utilize regression modeling to predict the market value of most contracts. Despite the efficiency of those methods, a regression model fitted to a small amount of data produces substantial prediction errors, and thus, it is challenging to rely on existing frameworks when highly accurate valuation results are desired or required. In this paper, we propose a novel hybrid framework that effectively chooses and assesses easy-to-predict contracts using the random forest model while leaving hard-to-predict contracts for the Monte Carlo simulation. The effectiveness of the hybrid approach is illustrated with an experimental study.

In this study, we quantify the relationship between socio-economic status and life expectancy and identify combinations of socio-economic variables that are particularly useful for explaining mortality differences between neighbourhoods in England. We achieve this by examining socio-economic variation in mortality experiences across small areas in England known as lower layer super output areas (LSOAs). We then consider 12 socio-economic variables that are known to have a strong association with mortality. We estimate the relationship between those variables and mortality rates using a random forest algorithm. Based on the resulting estimate, we then create a new socio-economic mortality index – the Longevity Index for England (LIFE). The index is constructed in a way that eliminates the impact of care homes that might artificially increase mortality rates in LSOAs with care homes compared to LSOAs that do not contain a care home. Using mortality data for different age groups, we make the index age-dependent and investigate the impact of specific socio-economic characteristics on the age-specific mortality risk. We compare the explanatory power of the LIFE index to the English Index of Multiple Deprivation (IMD) as predictors of mortality. While we find that the IMD can explain regional mortality differences to some extent, the LIFE index has significantly greater explanatory power for mortality differences between regions. Our empirical results also indicate that income deprivation amongst the elderly and employment deprivation are the most significant socio-economic factors for explaining mortality variation across LSOAs in England.

We study a stochastic model for a target benefit pension plan suffering from rising longevity and falling fertility. Policies for postponing retirement are carried out to hedge the payment difficulties caused by the aging population. The plan members’ contributions are set in advance while the pension payments reflect intergenerational equity by a target payment level and intergenerational risk sharing by an adjustment. The pension fund is invested in both a risk-free asset and a risky asset. Applying the stochastic optimal control methods, we derive analytic solutions for optimal investment and benefit payment strategies which minimize the benefit risk. Besides, an optimal delayed retirement age which can hedge against the aging phenomenon under certain parameters is given. Therefore, it can provide a basis for quantifying the delay of retirement time.

In pricing insurance contracts based on the individual policyholder’s aggregate losses for non-life insurers, the literature has mainly focused on using detailed information from policies and closed claims. However, the information on open claims can reflect shifts in the distribution of the expected claim payments better than closed claims. Such shifts may be needed to be reflected in the ratemaking process earlier rather than later, especially when insurers are experiencing environmental changes. In practice, actuaries use ad hoc techniques to adjust data to current levels to determine premiums. This paper presents an intuitive ratemaking model, employing a marked Poisson process framework, which ensures that the multivariate risk analysis is done more routinely using all reported claims and makes an adjustment for Incurred But Not Reported claims. Utilizing data from the Wisconsin Local Government Property Insurance Fund, we find that by determining rates based on current data, the proposed ratemaking model leads to better alignment of premiums and provides insurers with a more financially sound portfolio.

We formalize a consumption–investment–insurance problem with the distinction of a state-dependent relative risk aversion. The state dependence refers to the state of the finite state Markov chain that also formalizes insurable risks such as health and lifetime uncertainty. We derive and analyze the implicit solution to the problem, compare it with special cases in the literature, and illustrate the range of results in a disability model where the relative risk aversion is preserved, decreases, or increases upon disability.

The prominence of the Euler allocation rule (EAR) is rooted in the fact that it is the only return on risk-adjusted capital (RORAC) compatible capital allocation rule. When the total regulatory capital is set using the value-at-risk (VaR), the EAR becomes – using a statistical term – the quantile-regression (QR) function. Although the cumulative QR function (i.e., an integral of the QR function) has received considerable attention in the literature, a fully developed statistical inference theory for the QR function itself has been elusive. In the present paper, we develop such a theory based on an empirical QR estimator, for which we establish consistency, asymptotic normality, and standard error estimation. This makes the herein developed results readily applicable in practice, thus facilitating decision making within the RORAC paradigm, conditional mean risk sharing, and current regulatory frameworks.

This paper introduces a flexible risk decomposition method for life insurance contracts embedding several risk factors. Hedging can be naturally embedded in the framework. Although the method is applied to variable annuities in this work, it is also applicable in general to other insurance or financial contracts. The approach relies on applying an allocation principle to components of a Shapley decomposition of the gain and loss. The implementation of the allocation method requires the use of a stochastic on stochastic algorithm involving nested simulations. Numerical examples studying the relative impact of equity, interest rate and mortality risk for guaranteed minimal maturity benefit (GMMB) policies conclude our analysis.

We study a distributionally robust reinsurance problem with the risk measure being an expectile and under expected value premium principle. The mean and variance of the ground-up loss are known, but the loss distribution is otherwise unspecified. A minimax problem is formulated with its inner problem being a maximization problem over all distributions with known mean and variance. We show that the inner problem is equivalent to maximizing the problem over three-point distributions, reducing the infinite-dimensional optimization problem to a finite-dimensional optimization problem. The finite-dimensional optimization problem can be solved numerically. Numerical examples are given to study the impacts of the parameters involved.

Fuelled by the big data explosion, a new methodology to estimate sub-annual death probabilities has recently been proposed, opening new insurance business opportunities. This new approach exploits all the detailed information available from millions of microdata records to develop seasonal-ageing indexes (SAIs) from which sub-annual (quarterly) life tables can be derived from annual tables. In this paper, we explore whether a shortcut could be taken in the estimation of SAIs and (life insurance) sub-annual death rates. We propose three different approximations, in which estimates are attained by using just a small bunch of thousands of data records and assess their impact on several competitive markets defined from an actual portfolio of life insurance policies. Our analyses clearly point to the shortcuts as good practical alternatives that can be used in real-life insurance markets. Noticeably, we see that embracing the new quarterly based approach, even using only an approximation (shortcut), is economically preferable to using the associated annual table, offering a significant competitive advantage to the company adopting this innovation.