Download or read book Aggregate Lapsation Risk written by Ralph S. J. Koijen and published by . This book was released on 2022 with total page 0 pages. Available in PDF, EPUB and Kindle. Book excerpt: We study aggregate lapsation risk in the life insurance sector. Using the regulatory reporting of historical lapse rates by life insurers, we empirically document the counter-cyclicality of lapsation behavior. We construct two lapsation risk factors that explain a large fraction of the common variation in lapse rates of the 30 largest life insurance companies. The first is a cyclical factor that correlates with credit spreads and employment, while the second factor is a trend factor that correlates with the level of interest rates. Using a novel policy-level database from a large life insurer, we examine the heterogeneity in risk factor exposures based on policy and policyholder characteristics. Young policyholders with higher health risk are more likely to lapse their policies during economic downturns. We explore the implications for hedging and valuation of life insurance contracts. Ignoring aggregate lapsation risk results in cross-subsidization across policyholders with different lapsation risk, and in a mispricing of life insurance policies. Our results have implications for the welfare costs of business cycles.