Traditional participating life insurance contracts typically provide a guaranteed benefit at maturity resulting from some guaranteed minimum interest rate. On top of this guaranteed interest rate, surplus is credited to the contract in case of good performance of the insurer’s assets. In many countries, in particular in Continental Europe, the guaranteed rate is applied each year, also on surplus from previous years. This is often referred to as year-to-year guarantee or cliquet-style guarantee.

Products with cliquet-style guarantees have come under pressure in the current situation of low interest rates and volatile capital markets, in particular when priced in a market-consistent valuation framework such as MCEV. In addition, such guarantees lead to rather high capital requirements under risk based solvency frameworks such as Solvency II.

Since capital requirement alone is not a suitable figure for steering a product portfolio from an insurer’s perspective, we introduce a measure for “Capital Efficiency” that considers both, profits and capital requirements. We then introduce several alternative models for surplus participation, analyze their impact on the insurer’s financial situation, in particular on Capital Efficiency, and compare the results to the traditional product design.

To perform these analyses, we conduct a market consistent valuation of the products, and analyze the key drivers of Capital Efficiency, particularly the value of the embedded options. Furthermore, we compare the asymmetric distribution of profits between policyholders and shareholders, and investigate potential shortfalls of the customers’ accounts implying additional contributions by the shareholders. We illustrate the features of the proposed modified products to the audience and explain why they enhance Capital Efficiency. We show the relationship between product design, Capital Efficiency, profit chances and shortfall risks in the context of Solvency II, and argue why certain product characteristics will be necessary to support sustainability in this framework.