Mitigating Interest Rate Risk in Variable Annuities: An Analysis of Hedging Effectiveness Under Model Risk

40 Pages Posted: 26 Apr 2016  

Maciej Augustyniak

University of Montreal - Department of Mathematics and Statistics

Mathieu Boudreault

University of Quebec at Montreal (UQAM)

Date Written: April 25, 2016

Abstract

Variable annuities are investment vehicles offered by insurance companies that combine a life insurance policy with long-term financial guarantees. These guarantees expose the insurer to market risks, such as volatility and interest rate risks, which can only be managed with a hedging strategy. The objective of this article is to study the effectiveness of dynamic Greeks-based hedging strategies for mitigating interest rate risk in variable annuities with either a guaranteed minimum death benefit (GMDB) or guaranteed minimum withdrawal benefit (GMWB) rider. Our analysis centers on three important practical issues: (i) the robustness of interest rate hedges to model uncertainty, (ii) the impact of guarantee features (maturity versus withdrawal benefits) on the performance of the hedging strategy, and (iii) the importance of hedging interest rate risk in either a low and stable or rising interest rate environment. Overall, we find that the impact of interest rate risk is equally felt for the two types of products considered, and that interest rate hedges do lead to a significant risk reduction for the insurer, even when the ongoing low interest rate environment is factored in.

Keywords: segregated funds, equity-linked life insurance, stochastic interest rates, risk management, model uncertainty

Suggested Citation

Augustyniak, Maciej and Boudreault, Mathieu, Mitigating Interest Rate Risk in Variable Annuities: An Analysis of Hedging Effectiveness Under Model Risk (April 25, 2016). Available at SSRN: https://ssrn.com/abstract=2769927

Maciej Augustyniak (Contact Author)

University of Montreal - Department of Mathematics and Statistics ( email )

C.P. 6128, succursale Centre-ville
Montreal, Quebec H3C 3J7
Canada

HOME PAGE: http://dms.umontreal.ca/

Mathieu Boudreault

University of Quebec at Montreal (UQAM) ( email )

PB 8888 Station DownTown
Succursale Centre Ville
Montreal, Quebec H3C3P8
Canada

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