A Note on the Impact of Management Fees on the Pricing of Variable Annuity Guarantees

23 Pages Posted: 13 May 2017

See all articles by Jin Sun

Jin Sun

University of Technology Sydney (UTS)

Pavel V. Shevchenko

Macquarie University; Macquarie University, Macquarie Business School

Simon Man Chung Fung

Commonwealth Bank of Australia

Date Written: May 12, 2017

Abstract

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

Sun, Jin and Shevchenko, Pavel V. and Fung, Man Chung, A Note on the Impact of Management Fees on the Pricing of Variable Annuity Guarantees (May 12, 2017). Available at SSRN: https://ssrn.com/abstract=2967045 or http://dx.doi.org/10.2139/ssrn.2967045

Jin Sun (Contact Author)

University of Technology Sydney (UTS) ( email )

15 Broadway, Ultimo
PO Box 123
Sydney, NSW 2007
Australia

Pavel V. Shevchenko

Macquarie University ( email )

North Ryde
Sydney, New South Wales 2109
Australia

HOME PAGE: http://www.businessandeconomics.mq.edu.au/contact_the_faculty/all_fbe_staff/pavel_shevchenko

Macquarie University, Macquarie Business School ( email )

New South Wales 2109
Australia

Man Chung Fung

Commonwealth Bank of Australia

CBP
Sydney, NSW 2064
Australia

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