Fair Valuation of Equity-Linked Policies under Insurer Default Risk

Massimo Costabile, Ivar Massabò and Emilio Russo

North American Actuarial Journal, 2011, vol. 15, issue 4, 517-534

Abstract: We consider the problem of computing the fair value of equity-linked policies with an interestrate guarantee when the insurer is subject to credit risk. The framework is developed based on modern financial theory using the no-arbitrage principle. In this context, an equity-linked policy is considered as a vulnerable contingent claim that expires before maturity if the firm asset value reaches a prespecified default threshold depending on the firm’s liabilities. We derive a closedform formula in a continuous-time environment to compute the fair value of the contract. We also develop a discrete-time model that allows us to address fair evaluation when the policy embeds a surrender option.

Date: 2011
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DOI: 10.1080/10920277.2011.10597636

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