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Valuation of equity-linked life insurance contracts with surrender guarantees in a regime-switching rational expectation model

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  • Filip Uzelac
  • Alexander Szimayer

Abstract

We develop a regime-switching rational expectation model, where both the market value of a reference fund and the surrender intensity of a policyholder change randomly over time according to the evolution of a continuous-time Markov chain with a finite number of states. The contract value of a representative policyholder is characterized as a solution of a system of coupled PDEs, which we solve numerically by the Crank--Nicolson scheme combined with a penalty method. The paper is complemented by extensive numerical experiments, where we study the effect of the model parameters on the contract values and, particularly, surrender option values and also compare our regime-switching rational expectation model with the regime-switching American-style surrender model.

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  • Filip Uzelac & Alexander Szimayer, 2014. "Valuation of equity-linked life insurance contracts with surrender guarantees in a regime-switching rational expectation model," Quantitative Finance, Taylor & Francis Journals, vol. 14(2), pages 357-368, February.
    • Handle: RePEc:taf:quantf:v:14:y:2014:i:2:p:357-368
    DOI: 10.1080/14697688.2013.783287
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    Cited by:

    1. Cheng, Chunli, 2022. "Beyond death: The impact of a population-wide health shock on life insurance," The North American Journal of Economics and Finance, Elsevier, vol. 63(C).
    2. Weinert, Jan-Hendrik, 2017. "The fair surrender value of a tontine," ICIR Working Paper Series 26/17, Goethe University Frankfurt, International Center for Insurance Regulation (ICIR).
    3. Srbinoski Bojan & Strozzi Fernanda & Poposki Klime & Born Patricia H., 2020. "Trends in Life Insurance Demand and Lapse Literature," Asia-Pacific Journal of Risk and Insurance, De Gruyter, vol. 14(2), pages 1-46, July.
    4. Forsyth, Peter & Vetzal, Kenneth, 2014. "An optimal stochastic control framework for determining the cost of hedging of variable annuities," Journal of Economic Dynamics and Control, Elsevier, vol. 44(C), pages 29-53.

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