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Hedging and Cash Flows in the Presence of Taxes and Expenses in Life and Pension Insurance

Author

Listed:
  • Kristian Buchardt

    (PFA Pension, Sundkrogsgade 4, DK-2100 Copenhagen, Denmark
    These authors contributed equally to this work.)

  • Thomas Møller

    (PFA Pension, Sundkrogsgade 4, DK-2100 Copenhagen, Denmark
    Department of Mathematical Sciences, University of Copenhagen, Universitetsparken 5, DK-2100 Copenhagen, Denmark
    These authors contributed equally to this work.)

Abstract

In investment and insurance contracts, certain stipulated payments may depend on the hedging strategy. We study the problem of calculation, hedging and valuation of such cash flows, by considering a payment process in a setup with taxes and investment costs that are functions of the investment returns or the current value of the hedging strategy. We determine the market value of the combined liability and decompose the value into the tax part, the investment cost part and the benefit part, and we determine the associated hedging strategies. Moreover, we identify the expected future tax payments and investment cost cash flows. Our results show that the current Danish insurance accounting practice for taxes is in general conservative, when considered in an idealized setting with symmetric and continuously-paid taxes. Finally, we consider the special case of affine interest rates, where explicit results can be obtained, and study some numerical results.

Suggested Citation

  • Kristian Buchardt & Thomas Møller, 2018. "Hedging and Cash Flows in the Presence of Taxes and Expenses in Life and Pension Insurance," Risks, MDPI, vol. 6(3), pages 1-25, July.
    • Handle: RePEc:gam:jrisks:v:6:y:2018:i:3:p:68-:d:156195
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    References listed on IDEAS

    as
    1. Leland, Hayne E, 1985. "Option Pricing and Replication with Transactions Costs," Journal of Finance, American Finance Association, vol. 40(5), pages 1283-1301, December.
    2. Damgaard, Anders, 2003. "Utility based option evaluation with proportional transaction costs," Journal of Economic Dynamics and Control, Elsevier, vol. 27(4), pages 667-700, February.
    3. Møller,Thomas & Steffensen,Mogens, 2007. "Market-Valuation Methods in Life and Pension Insurance," Cambridge Books, Cambridge University Press, number 9780521868778, November.
    4. Damgaard, Anders, 2006. "Computation of reservation prices of options with proportional transaction costs," Journal of Economic Dynamics and Control, Elsevier, vol. 30(3), pages 415-444, March.
    5. McCulloch, J Huston, 1975. "The Tax-Adjusted Yield Curve," Journal of Finance, American Finance Association, vol. 30(3), pages 811-830, June.
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