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Guaranteed Annuity Options

Published online by Cambridge University Press:  17 April 2015

Phelim Boyle  and
Mary Hardy
Phelim Boyle
Affiliation:
Centre for Advanced Studies in Finance, School of Accountancy, University of Waterloo, Waterloo, Ontario, Canada N2L 3G1
Mary Hardy
Affiliation:
Statistics and Actuarial Science, University of Waterloo, Waterloo, Ontario Canada N2L 3G1
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Abstract

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Under a guaranteed annuity option, an insurer guarantees to convert a policyholder's accumulated funds to a life annuity at a fixed rate when the policy matures. If the annuity rates provided under the guarantee are more beneficial to the policyholder than the prevailing rates in the market the insurer has to make up the difference. Such guarantees are common in many US tax sheltered insurance products. These guarantees were popular in UK retirement savings contracts issued in the 1970's and 1980's when long-term interest rates were high. At that time, the options were very far out of the money and insurance companies apparently assumed that interest rates would remain high and thus that the guarantees would never become active. In the 1990's, as long-term interest rates began to fall, the value of these guarantees rose. Because of the way the guarantee was written, two other factors influenced the cost of these guarantees. First, strong stock market performance meant that the amounts to which the guarantee applied increased significantly. Second, the mortality assumption implicit in the guarantee did not anticipate the improvement in mortality which actually occurred.

The emerging liabilities under these guarantees threatened the solvency of some companies and led to the closure of Equitable Life (UK) to new business. In this paper we explore the pricing and risk management of these guarantees.

Type
Articles
Information
ASTIN Bulletin: The Journal of the IAA , Volume 33 , Issue 2 , November 2003 , pp. 125 - 152
Copyright
Copyright © ASTIN Bulletin 2003

Footnotes

1

Both authors acknowledge the support of the National Science and Engineering Research Council of Canada.

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