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2048. An analytical study of variable annuities with surrender option

Invited abstract in session MA-63: Applications in Finance and Economics, stream OR in Banking, Finance and Insurance: New Tools for Risk Management.

Monday, 8:30-10:00
Room: S14 (building: 101)

Authors (first author is the speaker)

1. Gabriele Stabile
Dipartimento di Metodi e Modelli per l'Economia, il Territorio e la Finanza, Sapienza-Università di Roma
2. Alessandro Milazzo
University of Torino
3. Tiziano De Angelis
University of Torino

Abstract

Variable annuities (VAs) are insurance contracts designed to meet retirement and long-term investment goals. These products combine the participation in equity performance with insurance coverages. The
subscriber of a VA (policyholder) enters the contract by paying a premium, and chooses to invest it from a selection of investment funds. Besides the life insurance protection, VAs provide a number of financial
guarantees and options. A minimum rate is guaranteed by the insurer in order to protect the policyholder’s capital against market downturns. Moreover, the policyholder has the right to early terminate the contract
(surrender option) and to receive the account value. In general, a penalty is applied by the insurer in case of early surrender, which decreases in time. These financial guarantees are financed by a fee paid by the
policyholder, typically in the form of a fixed proportion of the account value. At maturity, the policyholder can choose to obtain the account value or convert it into an annuity stream. These features of the VAs contracts are liabilities to the issuer and constitute a potential hazard to company solvency. In this paper we provide an analytical study of the pricing formula for the VAs and a characterisation of the optimal exercise
strategy for the surrender option.

Keywords

Status: accepted

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