Wei-Hsiang (Andy) Lin

A moneyness-adapting fee structure for guaranteed benefits embedded in variable annuities: Pricing and valuation

Guaranteed minimum death benefit (GMDB) and guaranteed minimum maturity benefit (GMMB) are two common guaranteed benefits embedded in variable annuities. To cover the financial risks incurring from the guarantees, management fees are charged based on the value of underlying funds, where a traditional approach funds the guarantees as a constant rate over the policy duration. This fee structure, however, potentially encourages surrendering when the options are far out-of-money. To prevent the adverse incentives, Bernard et al. (2014) introduced a state-dependent fee, where fees are charged only when the guarantees are in-the-money or close to being in-the-money. This project proposes a moneyness-adapting fee structure, aiming to further reduce insurer’s reserve while retaining the attractiveness of product features. Following the estimation of rate of fee charged for GMDB and/or GMMB under three pricing principles, the performances of the fee structures are compared with numerical illustrations, based on the measures of value-at-risk and conditional-tail-expectation, under some commonly adopted mortality, interest rate, and underlying asset price models.