CH 27 (Cost of Guarantees and Options) Flashcards
Examples of Investment Guarantees
- Guaranteed minimum maturity values
- Guaranteed minimum surrender values
- Ability to convert lump sum into annuity (or vice versa) on guaranteed terms
Methods of Assessing the Implied Guarantee Liability
- Option-pricing techniques
= Market valuation (value of liabilities will be similar to cost of derivative covering similar guarantee/option) - Stochastic simulation (modelling the extra sums likely needed through simulating investment returns… Use model of rates of return)
Valuing Mortality Option
Additional benefits and expenses that would be due under the option being exercised
vs
Actual premium that will be charged
…Through CF Projection
(probabilities can be done via Conventional or North American I think)
Assumptions required for investment option
- Take-up rate
- Mean and variance of investment returns
- Expenses relating to option
Assumptions required for mortality option
- Take-up rate
- Benefit chosen (if at p/holder discretion)
- Mortality of option exercisers (and abstainers)
- Expenses relating to option
Guaranteed Pricing Using Option Pricing
Guaranteed min maturity = European put option
Guaranteed min surrender = American put option (or series of put options)
Guaranteed annuity rate = Call option or Swaption (option to swap floating rate return for fixed rate)
Examples of Mortality Options
- Additional benefits purchased without further proof of help
- Renew policy without further proof of health
- Change part of SA from one contract to another
Factors Affecting Extent of Mortality Option Impact
TEN SEC - Term of the policy with the option - Encouragement to policyholders to exercise the option - Number of times the policyholder can exercise - Selective withdrawals - Extra cost to the policyholder who exercises - Conditions attaching to exercising the option (e.g. limited option size)
