Valuation of the Minimum Guaranteed Return Embedded in Life Insurance Products
Posted: 23 Apr 1998
Date Written: May 1996
Consider a traditional life insurance contract paid with a single premium. In addition to mortality factors, the relationship between the fixed amount of benefit and the single premium depends on the interest rate (calculation rate). The calculation rate can be interpreted as the average rate the insurance company must earn on its investment in the insurance period to fulfill its future obligations. In many countries the traditional life insurance products include a fixed percentage guarantee on each year's return. This annual guarantee comes in addition to the fixed benefit. Furthermore, no extra premium is charged for this guarantee. In this article we present a model for the valuation of life insurance contracts including a guaranteed minimum return. The model is based on the notion of no arbitrage opportunities from the theories of financial economics. Numerical examples indicate that these guarantees may have substantial market values.
JEL Classification: G22
Suggested Citation: Suggested Citation