Evaluation of equity-linked products in the presence of policyholder surrender option using risk-control strategies

Patrice Gaillardetz, Saeb Hachem and Mehran Moghtadai

Annals of Actuarial Science, 2022, vol. 16, issue 1, 25-41

Abstract: Throughout the past couple of decades, the surge in the sale of equity-linked products has led to many discussions on the evaluation and risk management of surrender options embedded in these products. However, most studies treat such options as American/Bermudian style options. In this article, a different approach is presented where only a portion of the policyholders react optimally due to the belief that not all policyholders are rational. Through this method, a probability of surrender is obtained based on the option moneyness and the product is partially hedged using local risk-control strategies. This partial hedging approach is versatile since few assumptions are required for the financial framework. To compare the different surrender assumptions, the initial capital requirement for an equity-linked product is obtained under a regime-switching equity model. Numerical examples illustrate the dynamics and efficiency of this hedging approach.

Date: 2022
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