The Benefit of Life Insurance Contracts with Capped Index Participation When Stock Prices are Subject to Jump Risk

Faculty/Professorship: Banking and Financial Control  
Author(s): Mahayni, Antje; Muck, Matthias
Title of the Journal: Review of Derivatives Research
ISSN: 1573-7144
Publisher Information: Dordrecht [u.a.] : Springer Science + Business Media B.V,
Year of publication: 2017
Issue: First Online: 16 March 2017
Pages: 28 ; Online-Ressource
Language(s): English
DOI: 10.1007/s11147-017-9131-9
We analyze the benefit to the insured of newly traded, innovative life insurance contracts. On a sequence of yearly reference days, the insured can choose between a guaranteed return (linked to the insurer’s asset result) and a capped index participation. The cap is adjusted at the beginning of each year such that both alternatives have the same value and the option to select is costless (product structuring condition). We point out that this condition cannot always be met. If the guaranteed return exceeds the upper bound of the capped index participation, the insurer can make a side profit. We show that a rather low insurance result also implies a rather low stock exposure, even if the insured opts for the index participation. Concerning the impact of the index dynamics, we emphasize that it is important to distinguish between jump and diffusion risk because the pricing of jump risk has an impact on cap rates that can be offered to an insured. Finally, we show that the optimal decision strategy of a CRRA investor implies an index selection even if it is unfairly priced such that the insurer indeed makes a side profit.
Keywords: derivatives, life insurance, interest rate guarantees, capped index participation, monthly sum cap
Peer Reviewed: Ja
International Distribution: Ja
Type: Article
Year of publication: 1. June 2017