The Effect of Policyholders’ Rationality on Unit-Linked Life Insurance Contracts with Surrender Guarantees

22 Pages Posted: 17 Dec 2010

See all articles by Jing Li

Jing Li

Institute for Finanancial Economics and Statistics

Alexander Szimayer

University of Hamburg - Faculty of Economics and Business Administration

Date Written: December 15, 2010

Abstract

We study the valuation of unit-linked life insurance contracts with surrender guarantees. Instead of solving an optimal stopping problem, we propose a more realistic approach accounting for policyholders’ rationality in exercising their surrender option. The valuation is conducted at the portfolio level by assuming the surrender intensity to be bounded from below and from above. The lower bound corresponds to purely exogenous surrender and the upper bound represents the limited rationality of the policyholders. The valuation problem is formulated by a valuation PDE and solved with the finite difference method. We show that the rationality of the policyholders has a significant effect on average contract value and hence on the fair contract design. We also present the separating boundary between purely exogenous surrender and endogenous surrender. This provides implications on the predicted surrender activity of the policyholders.

Keywords: unit-linked life insurance contracts, surrender guarantee, limited rationality, fair contract analysis

JEL Classification: G13, G22, C65

Suggested Citation

Li, Jing and Szimayer, Alexander, The Effect of Policyholders’ Rationality on Unit-Linked Life Insurance Contracts with Surrender Guarantees (December 15, 2010). Available at SSRN: https://ssrn.com/abstract=1725769 or http://dx.doi.org/10.2139/ssrn.1725769

Jing Li (Contact Author)

Institute for Finanancial Economics and Statistics ( email )

Adenauerallee 24-42
Bonn, D-53113
Germany
0049-228-736104 (Phone)

Alexander Szimayer

University of Hamburg - Faculty of Economics and Business Administration ( email )

Von-Melle-Park 5
Hamburg, 20146
Germany

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