Regression-based Monte Carlo methods for stochastic control models: variable annuities with lifelong guarantees

Yao Tung Huang and Yue Kuen Kwok

Quantitative Finance, 2016, vol. 16, issue 6, 905-928

Abstract: We present regression-based Monte Carlo simulation algorithm for solving the stochastic control models associated with pricing and hedging of the guaranteed lifelong withdrawal benefit (GLWB) in variable annuities, where the dynamics of the underlying fund value is assumed to evolve according to the stochastic volatility model. The GLWB offers a lifelong withdrawal benefit, even when the policy account value becomes zero, while the policyholder remains alive. Upon death, the remaining account value will be paid to the beneficiary as a death benefit. The bang-bang control strategy analysed under the assumption of maximization of the policyholder’s expected cash flow reduces the strategy space of optimal withdrawal policies to three choices: zero withdrawal, withdrawal at the contractual amount or complete surrender. The impact on the GLWB value under various withdrawal behaviours of the policyholder is examined. We also analyse the pricing properties of GLWB subject to different model parameter values and structural features.

Date: 2016
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DOI: 10.1080/14697688.2015.1088962

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