Revisiting the Risk-Neutral Approach to Optimal Policyholder Behavior: A Study of Withdrawal Guarantees in Variable Annuities

55 Pages Posted: 5 Mar 2021

See all articles by Thorsten Moenig

Thorsten Moenig

Temple University, Department of Risk, Insurance & Healthcare Management

Daniel Bauer

University of Wisconsin-Madison

Date Written: March 4, 2021

Abstract

Policyholder exercise behavior presents an important risk factor for pricing Variable Annuities. However, approaches presented in the literature—building on value-maximizing strategies akin to pricing American options—do not square with observed price and exercise patterns for popular withdrawal guarantees. We show that including taxes into the valuation closes this gap between theory and practice. In particular, we develop a subjective risk-neutral valuation methodology that takes into consideration differences in the tax structure between investment opportunities. We demonstrate that accounting for tax advantages significantly affects the value of the guarantees and produces results that are in line with empirical patterns.

JEL Classification: G22, D14, C61

Suggested Citation

Moenig, Thorsten and Bauer, Daniel, Revisiting the Risk-Neutral Approach to Optimal Policyholder Behavior: A Study of Withdrawal Guarantees in Variable Annuities (March 4, 2021). Available at SSRN: https://ssrn.com/abstract=3797995 or http://dx.doi.org/10.2139/ssrn.3797995

Thorsten Moenig (Contact Author)

Temple University, Department of Risk, Insurance & Healthcare Management ( email )

Fox School of Business and Management
1301 Cecil B. Moore Ave.
Philadelphia, PA 19122
United States

Daniel Bauer

University of Wisconsin-Madison ( email )

975 University Avenue
Madison, WI 53706
United States

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