Annuity Risk Management. One-year VaR Decomposition: A case study
Document ID: 2007-763 (previously 2007/001)
Published on: 1st February 2007
Author: Delme Pritchard
The main risk drivers contributing to ICA capital requirements for annuity business are longevity risk, credit risk (where backing funds are invested in credit risky assets) and interest rate risk. The aim of this research note is to investigate how the ICA capital can be attributed to these risk drivers in a case study. In particular we look at:
- The capital required for longevity risk and interest rate risk;
- The capital required for credit risk alone; and
- The diversification benefit achieved from holding both of these two sets of largely independent risks
It turns out that the diversification benefit between these risk drivers is in fact greater than if they were independent due to negative correlations in the tail of their joint distribution. This suggests that the result of combining the capital from these individual risk groups under the assumption of independence will lead to an overstatement of capital, under a one-year VaR ICA definition.
