A Note on the Impact of Management Fees on the Pricing of Variable Annuity Guarantees
23 Pages Posted: 13 May 2017
Date Written: May 12, 2017
Variable annuities, as a class of retirement income products, allow equity market exposure for a policyholder’s retirement fund with electable additional guarantees to limit the downside risk of the market. Management fees and guarantee insurance fees are charged respectively for the market exposure and for the protection from the downside risk. We investigate the impact of management fees on the pricing of variable annuity guarantees under optimal withdrawal strategies. Two optimal strategies, from policyholder’s and from insurer’s perspectives, are respectively formulated and the corresponding pricing problems are solved using dynamic programming. Our results show that when management fees are present, the two strategies can deviate significantly from each other, leading to a substantial difference of the guarantee insurance fees. This provides a possible explanation of lower guarantee insurance fees observed in the market. Numerical experiments are conducted to illustrate our results.
Keywords: Variable Annuity Guarantees, Guaranteed Minimum Withdrawal Benefits, Management Fees, Stochastic Optimal Control, PDE, Finite Difference
JEL Classification: G22, C61, G13
Suggested Citation: Suggested Citation