Impact of Hedging Strategy on Capital Charges for Variable Annuity Portfolios

Abstract

Efficient and robust techniques are crucial for hedging a book of variable annuities. For insurers, the profitability of variable annuity contracts heavily depend on the hedging schemes used to mitigate their associated financial liabilities. Beyond financial performance, the inclusion of protection, in the form of protective put options, in hedging portfolios contributes to reduce the capital charges imposed on the insurer. Although this external source of profit affect the total performance of the hedge, it has not been quantified in the literature. This paper fills that gap by quantifying the contribution of capital charge reductions to hedging performance for a number of hedging methodologies. We provide statistics using price simulations following normal and student distributions with fatter tails.