Insurance with Profit Participation

With e 3.73 Trillions in liabilities in 2016, participating policies represent the largest single life insurance liability in the European Economic Area. Evidence from a subset of life insurance companies reporting simultaneously under Solvency I and Solvency II suggests that the new regulation has on average increased the marginal cost of participating policies by 13.5%. At the same time, regulatory filings from several constrained life insurance companies indicate plans to reduce discretionary benefits in response to the change in regulation. I develop a stylised model of discretionary benefits to explain insurers' responses. I find that it is generally suboptimal to reduce discretionary benefits in response to higher capital requirements, provided the insurer is relatively unconstrained.