Explicit portfolio for unit-linked life insurance contracts with surrender option

Abstract

Introducing a surrender option in unit-linked life insurance contracts leads to a dependence between the surrender time and the financial market. [J. Barbarin, Risk minimizing strategies for life insurance contracts with surrender option, Tech. rep., University of Louvain-La-Neuve, 2007] used a lot of concepts from credit risk to describe the surrender time in order to hedge such types of contracts. The basic assumption made by Barbarin is that the surrender time is not a stopping time with respect to the financial market. The goal of this article is to make the hedging strategies more explicit by introducing concrete processes for the risky asset and by restricting the hazard process to an absolutely continuous process. First, we assume that the risky asset follows a geometric Brownian motion. This extends the theory of [T. Møller, Risk-minimizing hedging strategies for insurance payment processes, Finance and Stochastics 5 (2001) 419–446], in that the random times of payment are not independent of the financial market. Second, the risky asset follows a Lévy process. For both cases, we assume the payment process contains a continuous payment stream until surrender or maturity and a payment at surrender or at maturity, whichever comes first.