Risk Management of Policyholder Behavior in Equity-Linked Life Insurance

The financial guarantees embedded in variable annuity contracts expose insurers to a wide range of risks, lapse risk being one of them. When policyholders’ lapse behavior differs from the assumptions used to hedge variable annuity contracts, the effectiveness of dynamic hedging strategies can be significantly impaired. By studying how the fee structure and surrender charges affect surrender incentives, we obtain new theoretical results on the optimal surrender region and use them to design a marketable contract that is never optimal to lapse.