This exercise focuses on stress testing of lapse risk in life insurance business. The main interest here is to introduce the method rather than analyse the results of the calculations.
Some assumptions of lapse levels need to be made for example when calculating technical provisions and solvency capital requirements based on Solvency II regulation. In this exercise we observe what happens to technical provisions in different kind of scenarios of lapse rates and compare those results to shock in Solvency II standard solvency capital requirement model (standard SCR-model).
Inverse Gaussian distribution is used as distribution of time for insurance policy to last. Average lapse rates of generic insurance portfolio are used for fixing parameters of Inverse Gaussian distribution. Correlations between lapses of different insurance policies’ is set by using connection of Brownian motion and Inverse Gaussian distribution.
The stress test method introduced here seems suitable for valuating lapse risk in different risk levels, checking suitability of Solvency II standard SCR-model and for estimating how macroeconomic scenarios could impact on solvency situation via lapse rates.