A cohort-based Partial Internal Model for demographic risk

Abstract: We investigate the quantification of demographic risk in a framework consistent with the market-consistent valuation imposed by Solvency II. We provide compact formulas for evaluating inflows and outflows of a portfolio of insurance policies based on a cohort approach. In this context, we maintain the highest level of generality in order to consider both traditional policies and equity-linked policies: therefore, we propose a market-consistent valuation of the liabilities. In the second step we evaluate the Solvency Capital Requirement of the idiosyncratic risk, linked to accidental mortality, and the systematic risk one, also known as trend risk, proposing a formal closed formula for the former and an algorithm for the latter. We show that accidental volatility depends on the intrinsic characteristics of the policies of the cohort (Sums-at-Risk), on the age of the policyholders and on the variability of the sums insured; trend risk depends both on accidental volatility and on the longevity forecasting model used.