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Valuation and hedging of participating life-insurance policies under management discretion

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  • Kleinow, Torsten

Abstract

The valuation and hedging of participating life insurance policies, also known as with-profits policies, is considered. Such policies can be seen as European path-dependent contingent claims whose underlying security is the investment portfolio of the insurance company that sold the policy. The fair valuation of these policies is studied under the assumption that the insurance company has the right to modify the investment strategy of the underlying portfolio at any time. Furthermore, it is assumed that the issuer of the policy does not setup a separate portfolio to hedge the risk associated with the policy. Instead, the issuer will use its discretion about the investment strategy of the underlying portfolio to hedge shortfall risks. In that sense, the insurer's investment portfolio serves simultaneously as the underlying security and as the hedge portfolio. This means that the hedging problem can not be separated from the valuation problem. We investigate the relationship between risk-neutral valuation and hedging of these policies in complete and incomplete financial markets.

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  • Kleinow, Torsten, 2009. "Valuation and hedging of participating life-insurance policies under management discretion," Insurance: Mathematics and Economics, Elsevier, vol. 44(1), pages 78-87, February.
    • Handle: RePEc:eee:insuma:v:44:y:2009:i:1:p:78-87
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    References listed on IDEAS

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    1. Cummins, J. David & Miltersen, Kristian R. & Persson, Svein-Arne, 2004. "International Comparison of Interest Rate Guarantees in Life Insurance," Discussion Papers 2004/18, Norwegian School of Economics, Department of Business and Management Science.
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    5. Ballotta, Laura, 2005. "A Lévy process-based framework for the fair valuation of participating life insurance contracts," Insurance: Mathematics and Economics, Elsevier, vol. 37(2), pages 173-196, October.
    6. Brennan, Michael J. & Schwartz, Eduardo S., 1976. "The pricing of equity-linked life insurance policies with an asset value guarantee," Journal of Financial Economics, Elsevier, vol. 3(3), pages 195-213, June.
    7. Pelsser, Antoon, 2003. "Pricing and hedging guaranteed annuity options via static option replication," Insurance: Mathematics and Economics, Elsevier, vol. 33(2), pages 283-296, October.
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    Cited by:

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    2. Lin, Jyh-Horng & Li, Xuelian & Lin, Panpan, 2022. "Could we rely on credit swap hedging as a substitute for insurer blockchain technology involvement?," International Review of Economics & Finance, Elsevier, vol. 80(C), pages 266-281.
    3. Chen, Damiaan H.J. & Beetsma, Roel M.W.J. & van Wijnbergen, Sweder J.G., 2023. "Intergenerational sharing of unhedgeable inflation risk," Insurance: Mathematics and Economics, Elsevier, vol. 113(C), pages 140-160.
    4. Zemp, Alexandra, 2011. "Risk comparison of different bonus distribution approaches in participating life insurance," Insurance: Mathematics and Economics, Elsevier, vol. 49(2), pages 249-264, September.
    5. Frédéric Sart, 2016. "On the hedging of liabilities with an endogenous profit sharing mechanism," Post-Print hal-01574949, HAL.
    6. Lukasz Delong, 2010. "Applications of time-delayed backward stochastic differential equations to pricing, hedging and portfolio management," Papers 1005.4417, arXiv.org, revised Jan 2011.
    7. Bohnert, Alexander & Gatzert, Nadine & Jørgensen, Peter Løchte, 2015. "On the management of life insurance company risk by strategic choice of product mix, investment strategy and surplus appropriation schemes," Insurance: Mathematics and Economics, Elsevier, vol. 60(C), pages 83-97.

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