Assessing the Risk Potential of Premium Payment Options in Participating Life Insurance Contracts

Abstract

AbstractMost life insurance contracts embed the right to stop premium payments during the term of the contract (paid‐up option). Thereby, the contract is not terminated but continues with reduced benefits and often provides the right to resume premium payments later, thus increasing the previously reduced benefits (resumption option). In our analysis, we start with a basic contract with two standard options, namely, an interest rate guarantee and annual surplus participation. Next, in addition to the features of the basic contract, a paid‐up and resumption option is included in the framework. The valuation process is not based on assumptions about a particular policyholders' exercise strategy but instead assesses the risk potential from the insurer's viewpoint by providing an upper bound for any possible exercise behavior. This approach provides important information to the insurer about the potential hazard of offering the paid‐up and resumption option. Further, the approach allows an analysis of the impact of guaranteed interest rate, annual surplus participation, and investment volatility on the values of the premium payment options.