Intertemporal vs. intergenerational risk sharing: Effects on guarantees of life insurance products

In traditional life insurance, policyholders participate in a common pool of assets. This enables the insurer to implement a variety of smoothing mechanisms to reduce volatility of returns. Such products often include guarantees. In the academic literature on the analyses of these guarantees, corresponding smoothing mechanisms are often not or inadequately considered in the modelling framework. We argue that the concrete design of smoothing mechanisms can significantly impact the value of a guarantee, the provider’s risk, and the risk-return-characteristics of the resulting product. To illustrate this, we analyze stylized smoothing mechanisms based on Kling et al. (2024, 2025), i.e., smoothing mechanisms based on intergenerational risk sharing and intertemporal smoothing, combined with a terminal guarantee. To consistently compare products with different underlying funds, we apply fairness conditions under the real-world measure.Our main result is that smoothing mechanisms decrease the value of guarantees. Consequently, for the same price, a riskier underlying investment can be chosen, which leads to higher return potential while maintaining a similar risk profile compared to products without smoothing mechanism. These effects are especially pronounced for smoothing mechanisms based on intergenerational risk sharing. On the other hand, we find that the risk of providing a guarantee is mainly driven by its value, not the stock ratio of the underlying fund. The second part of the paper examines the fairness conditions of the smoothing mechanisms. We compare the initial products, calibrated for fairness under the real-world measure, with a calibration for fairness under the risk-neutral measure. This comparison reveals the differences between products based on a pool of generations and those that can be hedged on the capital market. The results demonstrate that the insurer’s unique ability to pool risks can lead to preferable payoff structures of the products. Furthermore, smoothing mechanisms have a stronger effect on the guarantee values if calibrated under the real-world measure.