Abstract
A variable annuity is an equity-linked financial product typically offered by insurance companies. The policyholder makes an upfront payment to the insurance company and, in return, the insurer is required to make a series of payments starting at an agreed upon date. For a higher premium, many insurance companies offer additional guarantees or options which protect policyholders from various market risks. This research is centered around two of these options: the guaranteed minimum income benefit (GMIB) and the reset option. The sensitivity of various parameters on the value of the GMIB is explored, particularly the guaranteed payment rate set by the insurer. Additionally, a critical value for future interest rates is calculated to determine the rationality of exercising the reset option. This will be able to provide insight to both the policyholder and policy writer on how their future projections on the performance of the stock market and interest rates should guide their respective actions of exercising and pricing variable annuity options. This can help provide details into the value of adding options to a variable annuity for companies that are looking to make variable annuity policies more attractive in a competitive market.
Highlights
A variable annuity is a long-term, tax-deferred product, whose funds are equity-linked from the time of the initial payment until the annuitization date
The value of the guaranteed minimum income benefit (GMIB) is given as a function of the guaranteed annual payment rate g to determine the fair rate g∗ for varying fee rates c and critical values for the reset option are given
A Monte Carlo simulation approach is used in the pricing of the GMIB to undertake the analysis
Summary
A variable annuity is a long-term, tax-deferred product, whose funds are equity-linked from the time of the initial payment until the annuitization date (the accumulation period). The growth of the investments during the accumulation phase affects the payout of the annuity at the annuitization date (often at retirement) This product is designed to provide post-retirement income. When insurance companies began to include guaranteed minimum benefits in their variable annuity products in the late 1990s, there was a large growth in the number of polices sold (Drexler, Plestis, & Rosen, 2017). This made variable annuities a more attractive option because it reduced the level of risk in these policies to policyholders.
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