The Thermodynamic Approach to Whole-Life Insurance: A Method for Evaluation of Surrender Risk

Abstract

We introduce a collective model for life insurance where the heterogeneity of each insured, including the health state, is modeled by a diffusion process. This model is influenced by concepts in statistical mechanics. Using the proposed framework, one can describe the total pay-off as a functional of the diffusion process, which can be used to derive a level premium that evaluates the risk of lapses due to the so-called adverse selection. Two numerically tractable models are presented to exemplify the flexibility of the proposed framework.