Dynamic lapse risk in an era of quantitative easing

The financial crisis offered a rude awakening to many insurers, who have improved their variable hedge protocols in recent years. However, one of the most valuable options commonly offered by insurers still requires closer scrutiny: book value withdrawals on general account products. This paper examines the risk associated with book value guarantees in the context of the products and economic environment of Japan. We show that this risk can be material and may apply to markets in the United States and worldwide as well. For many typical blocks of business sold in Japan, the value of embedded options, and therefore the best estimate liability reflecting option costs, depends materially on policyholder behavior assumptions. Given the potential for material exposure, it is critical that insurers undertake this analysis.