The Pricing for Interest Sensitive Products of Life Insurance Firms (Report‪)‬

1. Introduction Interest rate risk is an important concern for life insurance firms. Insurers issue debt instruments for which the amount and timings of benefits payment are unknown at time of policy issuance and invest the premiums to maximize the return. The asset cash flow is composed of investment income and principal repayments while the liability cash flow in any future time is defined as the sum of the policy claims, policy surrenders and expenses minus the premium income expected to occur in that time period. When interest rates fall as the net cash flows are positive, the net flows will have to be reinvested at rates lower than the initial rates. The reinvestment risk emerges. On the other hand, negative net cash flows mean shortages of cash needed to meet liability obligations. A cash shortage requires the liquidation of assets or borrowing. If interest rates rise when the net cash flows are negative, capital losses can occur as a result of liquidation of bonds and other fixed-income securities whose values have fallen. And the price risk occurs. Taiwan insurance companies are exposed largely to interest risk even though the popular products change over time. Prior to 1990, market was featured with fixed interest rate products which guarantee 20 or more years of fixed return to policyholders. With interest starts to decline in late 1990s, Taiwan insurers realize that high fixed interest products are too costly to issue but low fixed-interest rate products won't be attractive to potential buyers. With the sale pressure, insurance companies start to issue unit-linked products as well as interest sensitive products to attract buyers. Single paid deferred annuities (SPDA) which belongs to interest sensitive family quickly takes up almost 20% of new premiums in the market and therefore its risk exposure becomes vital to insurers' insolvency.