40 Pages Posted: 26 Apr 2016
Date Written: April 25, 2016
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: 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