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A Natural Hedge for Equity Indexed Annuities

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  • Bernard, Carole
  • Boyle, Phelim P.

Abstract

Equity linked products are popular in many countries. These contracts generally provide a guaranteed return combined with some participation in the market performance, often computed using a complicated formula. Hedging these contracts often presents a real challenge for insurers in particular during a financial crisis. In this paper, we explain how insurers can benefit from selling a pool of different contracts with different sensitivities to certain key variables to reduce risk exposure. We show how they can diversify their menu of policy designs to stabilize the market value of their liabilities against changes in the market volatility and against estimation error in the volatility parameter. We illustrate the methodology with specific examples of equity annuity contracts with opposite sensitivities to vega risk.

Suggested Citation

  • Bernard, Carole & Boyle, Phelim P., 2011. "A Natural Hedge for Equity Indexed Annuities," Annals of Actuarial Science, Cambridge University Press, vol. 5(2), pages 211-230, September.
    • Handle: RePEc:cup:anacsi:v:5:y:2011:i:02:p:211-230_00
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    References listed on IDEAS

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    Cited by:

    1. Kirkby, J. Lars & Nguyen, Duy, 2021. "Equity-linked Guaranteed Minimum Death Benefits with dollar cost averaging," Insurance: Mathematics and Economics, Elsevier, vol. 100(C), pages 408-428.
    2. Cui, Zhenyu & Kirkby, J. Lars & Nguyen, Duy, 2017. "Equity-linked annuity pricing with cliquet-style guarantees in regime-switching and stochastic volatility models with jumps," Insurance: Mathematics and Economics, Elsevier, vol. 74(C), pages 46-62.
    3. Hanna, Vanessa & Hieber, Peter & Devolder, Pierre, 2021. "Mixed participating and unit-linked life insurance contracts: design, pricing and optimal strategy," LIDAM Discussion Papers ISBA 2021010, Université catholique de Louvain, Institute of Statistics, Biostatistics and Actuarial Sciences (ISBA).

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