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High‐water mark fee structure in variable annuities

David Landriault, Bin Li, Dongchen Li and Yumin Wang

Journal of Risk & Insurance, 2021, vol. 88, issue 4, 1057-1094

Abstract: This paper proposes a novel high‐water mark fee structure and investigates its impact on the marketability of variable annuities. To evaluate the welfare effects of holding a variable annuity, we adopt mean‐variance analysis. By also examining the welfare effects of holding two alternative investments, we introduce a quantitative measure, namely a compatible set of risk aversions, to assess the marketability of the variable annuity under a certain fee structure. Comparing the compatible sets and the welfare effects of holding the variable annuity under the high‐water mark fee structure with those under a constant and a state‐dependent fee structure, we find that the high‐water mark fee structure improves the variable annuity's marketability in two aspects: First, it makes the variable annuity preferable to the alternative investments for a broader range of policyholders. Second, when the variable annuity is preferred over the alternative investments, it produces the highest welfare for the policyholder.

Date: 2021
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