Valuation of Variable Annuities with Guaranteed Minimum Withdrawal and Death Benefits via Stochastic Control Optimization

31 Pages Posted: 21 Nov 2014 Last revised: 25 Jul 2015

See all articles by Xiaolin Luo

Xiaolin Luo

Government of the Commonwealth of Australia - CSIRO (Commonwealth Scientific and Industrial Research Organisation)

Pavel V. Shevchenko

Macquarie University - Department of Actuarial Studies and Business Analytics

Date Written: February 10, 2015

Abstract

In this paper we present a numerical valuation of variable annuities with combined Guaranteed Minimum Withdrawal Benefit (GMWB) and Guaranteed Minimum Death Benefit (GMDB) under optimal policyholder behavior solved as an optimal stochastic control problem. This product simultaneously deals with financial risk, mortality risk and human behavior. We assume that market is complete in financial risk and mortality risk is completely diversified by selling enough policies and thus the annuity price can be expressed as appropriate expectation. The computing engine employed to solve the optimal stochastic control problem is based on a robust and efficient Gauss-Hermite quadrature method with cubic spline. We present results for three different types of death benefit and show that, under the optimal policyholder behavior, adding the premium for the death benefit on top of the GMWB can be problematic for contracts with long maturities if the continuous fee structure is kept, which is ordinarily assumed for a GMWB contract. In fact for some long maturities it can be shown that the fee cannot be charged as any proportion of the account value -- there is no solution to match the initial premium with the fair annuity price. On the other hand, the extra fee due to adding the death benefit can be charged upfront or in periodic instalment of fixed amount, and it is cheaper than buying a separate life insurance.

Keywords: Variable Annuity, Optimal Stochastic Control, Guaranteed Minimum Withdrawal Benefit, Guaranteed Minimum Death Benefit, Mortality Risk

Suggested Citation

Luo, Xiaolin and Shevchenko, Pavel V., Valuation of Variable Annuities with Guaranteed Minimum Withdrawal and Death Benefits via Stochastic Control Optimization (February 10, 2015). Insurance: Mathematics and Economics, Vol. 62 (2015), pp. 5-15, Available at SSRN: https://ssrn.com/abstract=2528355 or http://dx.doi.org/10.2139/ssrn.2528355

Xiaolin Luo

Government of the Commonwealth of Australia - CSIRO (Commonwealth Scientific and Industrial Research Organisation) ( email )

Riverside Corporate Park
Julius Avenue
Sydney, NSW 2113
Australia

HOME PAGE: http://www.cmis.csiro.au

Pavel V. Shevchenko (Contact Author)

Macquarie University - Department of Actuarial Studies and Business Analytics ( email )

Australia

HOME PAGE: http://www.mq.edu.au/research/centre-for-risk-analytics/pavel-shevchenko

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