Constrained Non-Concave Utility Maximization: An Application to Life Insurance Contracts with Guarantees
European Journal of Operational Research, Vol. 273, No. 3, pp. 1119-1135, 2019
40 Pages Posted: 11 Aug 2017 Last revised: 6 Dec 2018
Date Written: April 30, 2018
We study a problem of non-concave utility maximization under a fair pricing constraint. The framework finds many applications in, for example, the optimal design of managerial compensation or equity-linked life insurance contracts. Deriving closed-form solutions, we observe that the fair pricing constraint will reduce the riskiness of the optimal strategies substantially. In an extensive numerical section, we analyze innovative retirement products that adapt the investment strategy of the premium pool according to the policyholder's preferences, modeled as constant relative risk aversion (CRRA). Such products are a response to the loss of attractiveness of traditional life insurance contracts with guarantees that are negatively affected by increasing solvency requirements for return guarantees and a general decrease in interest rate levels. Taking into account that retirement products are usually tax-privileged, we find that fairly priced guarantee contracts that follow this optimal investment strategy lead to a higher expected utility level than asset investments.
Keywords: optimal asset alllocation, insurance contract design, investment guarantee, utility maximization
JEL Classification: G11, G23
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