State-Dependent Fees for Variable Annuity Guarantees

29 Pages Posted: 30 Apr 2013 Last revised: 27 Jul 2013

See all articles by Carole Bernard

Carole Bernard

Grenoble Ecole de Management; Vrije Universiteit Brussel (VUB)

Mary R. Hardy

University of Waterloo

Anne MacKay

University of Waterloo

Date Written: July 26, 2013

Abstract

For variable annuity policies, management fees for the most standard guarantees are charged at a constant rate throughout the term of the policy. This creates a misalignment of risk and income - the fee income is low when the option value is high, and vice versa. In turn, this may create adverse incentives for policyholders, for example, encouraging surrenders when the options are far out-of-the-money.

In this paper we explore a new fee structure for variable annuities, where the fee rates supporting the cost of guarantees depends on the moneyness of those guarantees. We derive formulas for calculating the fee rates assuming fees are paid only when the guarantees are in-the-money, or are close to being in-the-money, and we illustrate with some numerical examples. We investigate the effect of this new fee structure on the surrender decision.

Keywords: Variable annuities, pricing, GMMB, GMDB, surrender option

JEL Classification: G13, G22

Suggested Citation

Bernard, Carole and Hardy, Mary R. and MacKay, Anne, State-Dependent Fees for Variable Annuity Guarantees (July 26, 2013). Available at SSRN: https://ssrn.com/abstract=2258199 or http://dx.doi.org/10.2139/ssrn.2258199

Carole Bernard (Contact Author)

Grenoble Ecole de Management ( email )

12, rue Pierre Sémard
Grenoble Cedex, 38003
France

Vrije Universiteit Brussel (VUB) ( email )

Pleinlaan 2
http://www.vub.ac.be/
Brussels, 1050
Belgium

Mary R. Hardy

University of Waterloo ( email )

Waterloo, Ontario N2L 3G1
Canada

Anne MacKay

University of Waterloo ( email )

Waterloo, Ontario N2L 3G1
Canada

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