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Analysis of embedded options in individual pension schemes in Germany

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  • Alexander Kling
  • Jochen Russ
  • Hato Schmeiser

Abstract

Newly introduced government-subsidized pension products in Germany are required to contain a promise by the seller to provide a “money-back guarantee” at the end of the term. The client is also given the right to stop paying premiums at any time (paid-up option). In this case, the amount of all premiums paid must also be guaranteed by the seller at maturity, no matter when the client stopped paying the premiums. Previous analyses of guarantees in such government-subsidized pension products have ignored this additional option. Within a generalized Black/Scholes framework, we analyze the value of the paid-up option for different products, market scenarios, and client behavior. Our results indicate that the paid-up option significantly increases the value of the money-back guarantee. Furthermore, we find that reducing volatility by shifting the client’s assets from stocks to bonds as maturity approaches is a suitable means of reducing the risk arising from the “pure” money-back guarantee but much less effective in reducing the risk arising from the paid-up option. Copyright Springer Science + Business Media, LLC 2006

Suggested Citation

  • Alexander Kling & Jochen Russ & Hato Schmeiser, 2006. "Analysis of embedded options in individual pension schemes in Germany," The Geneva Papers on Risk and Insurance Theory, Springer;International Association for the Study of Insurance Economics (The Geneva Association), vol. 31(1), pages 43-60, July.
    • Handle: RePEc:kap:geneva:v:31:y:2006:i:1:p:43-60
    DOI: 10.1007/s10713-006-9467-9
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    References listed on IDEAS

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    3. Raphaël Douady, 2002. "Bermudan Option Pricing With Monte-Carlo Methods," World Scientific Book Chapters, in: Marco Avellaneda (ed.), Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar(Volume III), chapter 14, pages 314-328, World Scientific Publishing Co. Pte. Ltd..
    4. Marie-Eve Lachance & Olivia S. Mitchell, 2002. "Understanding Individual Account Guarantees," NBER Working Papers 9195, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Schmeiser, H. & Wagner, J., 2011. "A joint valuation of premium payment and surrender options in participating life insurance contracts," Insurance: Mathematics and Economics, Elsevier, vol. 49(3), pages 580-596.
    2. Nadine Gatzert & Hato Schmeiser, 2008. "Assessing the Risk Potential of Premium Payment Options in Participating Life Insurance Contracts," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 75(3), pages 691-712, September.
    3. Jan Vlachý, 2016. "Valuation of Contractual Assets Using Statistical Simulation," Contemporary Economics, University of Economics and Human Sciences in Warsaw., vol. 10(2), June.

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