Pricing of multi-period rate of return guarantees: The Monte Carlo approach

The uncertain yearly returns on both life and pension insurance policies are often bounded from below by a minimum guaranteed rate of return. It turns out that this yearly, or multi-period guarantee can have a very high economic value. However, because determining this value is a problem of high dim...

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Bibliographic Details
Published in:Insurance, mathematics & economics mathematics & economics, 2006-08, Vol.39 (1), p.135-149
Main Authors: Bakken, Henrik, Lindset, Snorre, Olson, Lars Hesstvedt
Format: Article
Language:English
Subjects:
Guarantees
Heath, Jarrow, and Morton term structure model
IB10
IE51
IM20
Insurance policies
Interest rates
Life insurance
Monte Carlo simulation
Multi-period rate of return guarantee
Rates of return
Stochastic interest rates
Stochastic processes
Studies
Uncertainty
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Summary:The uncertain yearly returns on both life and pension insurance policies are often bounded from below by a minimum guaranteed rate of return. It turns out that this yearly, or multi-period guarantee can have a very high economic value. However, because determining this value is a problem of high dimension, obtaining an estimate of it can be rather difficult and time-consuming. In this paper we present a numerical valuation method for estimating the market value of the multi-period guarantee when the uncertainty in the interest rates is modeled in a Heath, Jarrow, and Morton framework with an exponential volatility structure.
ISSN:0167-6687
1873-5959
DOI:10.1016/j.insmatheco.2006.02.001