Optimal Pension Insurance Design
AbstractIn this paper we analyze how the traditional life and pension contracts with a guaranteed rate of return can be optimized to increase customers’ welfare. Given that the contracts have to be priced correctly, we use individuals’ preferences to find the preferred design. Assuming CRRA utility, we cannot explain the existence of any form of guarantees. Through numerical solutions we quantify the difference (measured in certainty equivalents) to the preferred Merton solution of direct investments in a fixed proportion of risky and risk free assets. The largest welfare loss seems to come from the fact that guarantees are effective by the end of each year, not only by the expiry of the contract. However, the demand for products with guarantees may be explained through behavioral models. We use cumulative prospect theory as an example, showing that the optimal design is a simple contract with a life-time guarantee and no default option.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Department of Business and Management Science, Norwegian School of Economics in its series Discussion Papers with number 2006/14.
Length: 22 pages
Date of creation: 18 Oct 2006
Date of revision: 21 Jun 2007
Contact details of provider:
Postal: NHH, Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway
Phone: +47 55 95 92 93
Fax: +47 55 95 96 50
Web page: http://www.nhh.no/en/research-faculty/department-of-business-and-management-science.aspx
More information through EDIRC
Household Finance; Portfolio Choice; Life and Pension Insurance; Prospect Theory;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-10-28 (All new papers)
- NEP-FIN-2006-10-28 (Finance)
- NEP-IAS-2006-10-28 (Insurance Economics)
- NEP-UPT-2006-10-28 (Utility Models & Prospect Theory)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Consiglio, Andrea & Saunders, David & Zenios, Stavros A., 2006. "Asset and liability management for insurance products with minimum guarantees: The UK case," Journal of Banking & Finance, Elsevier, vol. 30(2), pages 645-667, February.
- Campbell, John, 2006.
3157877, Harvard University Department of Economics.
- Bjarne Astrup Jensen & Carsten Sørensen, 2001. "Paying for Minimum Interest Rate Guarantees: Who Should Compensate Who?," European Financial Management, European Financial Management Association, vol. 7(2), pages 183-211.
- Grosen, Anders & Lochte Jorgensen, Peter, 2000.
"Fair valuation of life insurance liabilities: The impact of interest rate guarantees, surrender options, and bonus policies,"
Insurance: Mathematics and Economics,
Elsevier, vol. 26(1), pages 37-57, February.
- Peter L›chte J›rgensen & Anders Grosen, . "Fair Valuation of Life Insurance Liabilities: The Impact of Interest Rate Guarantees, Surrender Options, and Bonus Policies," Management Working Papers 1999-1, School of Economics and Management, University of Aarhus.
- R. C. Merton, 1970.
"Optimum Consumption and Portfolio Rules in a Continuous-time Model,"
58, Massachusetts Institute of Technology (MIT), Department of Economics.
- Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
- Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
- Camerer, Colin F & Ho, Teck-Hua, 1994. "Violations of the Betweenness Axiom and Nonlinearity in Probability," Journal of Risk and Uncertainty, Springer, vol. 8(2), pages 167-96, March.
- Arjan B. Berkelaar & Roy Kouwenberg & Thierry Post, 2004.
"Optimal Portfolio Choice under Loss Aversion,"
The Review of Economics and Statistics,
MIT Press, vol. 86(4), pages 973-987, November.
- Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June.
- Francisco J. Gomes, 2005. "Portfolio Choice and Trading Volume with Loss-Averse Investors," The Journal of Business, University of Chicago Press, vol. 78(2), pages 675-706, March.
- Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- Døskeland, Trond M. & Nordahl, Helge A., 2006. "Intergenerational Effects of Guaranteed Pension Contracts," Discussion Papers 2006/13, Department of Business and Management Science, Norwegian School of Economics, revised 21 Jun 2007.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Stein Fossen).
If references are entirely missing, you can add them using this form.