Analytical approximations for prices of swap rate dependent embedded options in insurance products

Richard Plat and Antoon Pelsser ()

Insurance: Mathematics and Economics, 2009, vol. 44, issue 1, pages 124-134

Abstract: Life insurance products have profit sharing features in combination with guarantees. These so-called embedded options are often dependent on or approximated by forward swap rates. In practice, these kinds of options are mostly valued by Monte Carlo simulations. However, for risk management calculations and reporting processes, lots of valuations are needed. Therefore, a more efficient method to value these options would be helpful. In this paper analytical approximations are derived for these kinds of options, based on an underlying multi-factor Gaussian interest rate model. The analytical approximation for options with direct payment is almost exact while the approximation for compounding options is also satisfactory. In addition, the proposed analytical approximation can be used as a control variate in Monte Carlo valuation of options for which no analytical approximation is available, such as similar options with management actions. Furthermore, it's also possible to construct analytical approximations when returns on additional assets (such as equities) are part of the profit sharing rate.

Keywords: IE43; IE54; IB10; Embedded; options; Insurance; products; Analytical; approximation; Gaussian; interest; rate; model; Fair; Value; of; Liabilities (search for similar items in EconPapers)
Date: 2009

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Persistent link: http://EconPapers.repec.org/RePEc:eee:insuma:v:44:y:2009:i:1:p:124-134

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