Options
Implicit Options in Life Insurance Contracts: Valuation and Risk Management
Type
fundamental research project
Start Date
01 August 2006
End Date
31 January 2007
Status
completed
Keywords
Participating Life Insurance Contracts
Implicit Options
Risk-Neutral Valuation
Fair Contracts
Risk Management
International Financial Reporting Standards (IFRS)
Taxes
Simulation
Description
Most life insurance policies are replete with implicit (also called embedded) options that can be of significant value. In the past, many of these options were offered free of charge, which was partly because traditional actuarial methods were not capable of appropriately pricing the options. When British Equitable Life had to stop taking new business in 2000 due to improper hedging of provided options, concern over embedded options intensified, especially regarding the appropriate pricing of implicit options and the conduct of risk management. These concerns are also reflected in recent regulatory processes (see Solvency II, Swiss Solvency Test, IFRS), where financial reporting now requires a determination of the market value of liabilities, and thus implicit options at fair value. However, fair valuation requires an appropriate financial valuation model. Increasingly, actuaries are cooperating with financial economists in order to cope with this challenge. The fair valuation approach thus has an impact on the design of life insurance contracts and other related aspects. Alternatively, facets such as managerial behavior will have an influence on the claim structure and thus on fair valuation and the insolvency risk of the insurer. The aim of our research project is to analyze aspects related to the fair valuation of implicit options that have a substantial impact, particularly the measuring and managing of risk and the impact of corporate taxes.
Leader contributor(s)
Member contributor(s)
Funder(s)
Topic(s)
The Influence of Management Strategies on Fair Valuation and Insolvency Risk
The Effect of Corporate Taxes on Rate Making
The Effect of Corporate Taxes on Rate Making
Method(s)
Statistical and Actuarial Methods
Stochastic Modeling
Simulation
Stochastic Modeling
Simulation
Range
Institute/School
Range (De)
Institut/School
Division(s)
Eprints ID
29845
2 results
Now showing
1 - 2 of 2
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PublicationThe Influence of Corporate Taxes on Pricing and Capital Structure in Property-Liability InsuranceA change in the corporate tax level can have a significant impact on rate making and capital structure for insurance companies. The purpose of this paper is to study this effect on competitive equity-premium combinations for different asset and liability models while retaining a fixed safety level. This is a crucial consideration as a change in the tax rate leads, in general, to a different risk of insolvency. Hence, fixing the safety level serves to isolate the effect of taxes without shifting the insurer's risk situation whenever taxes are varied. The model framework includes stochastic assets as well as stochastic claims costs. We further compare the results for liability models with and without a jump component. Insurance rate making is conducted using option pricing theory.Type: journal articleJournal: Insurance: Mathematics and EconomicsVolume: 42Issue: 1
Scopus© Citations 15 -
PublicationAssessing the Risk Potential of Premium Payment Options in Participating Life Insurance ContractsMost life insurance contracts embed the right to stop premium payments during the term of the contract (paid-up option). Thereby, the contract is not terminated but continues with reduced benefits and often provides the right to resume premium payments later, thus reincreasing the previously reduced benefits (resumption option). In our analysis, we start with a basic contract with two standard options, namely, an interest-rate guarantee and cliquet-style annual surplus participation. Next, we include, in addition to the features of the basic contract, a paid-up and resumption option in the framework. We do not base our pricing on assumptions about particular exercise strategies, but instead assess the risk potential by providing an upper bound to the option price which is independent of the policyholder's exercise behavior. This approach provides important information to the insurer about the potential hazard of offering the paid-up and resumption option. Further, the approach allows an analysis of the impact of guaranteed interest rate, annual surplus participation, and investment volatility on the values of the premium payment options.Type: journal articleJournal: The Journal of Risk and InsuranceVolume: 75Issue: 3
Scopus© Citations 21