Risk comparison of different bonus distribution approaches in participating life insurance

The fair pricing of explicit and implicit options in life insurance products has received broad attention in the academic literature over the past years. Participating life insurance (PLI) contracts have been the focus especially. These policies are typically characterized by a term life insurance, a minimum interest rate guarantee, and bonus participation rules with regard to the insurer's asset returns or reserve situation. Researchers replicate these bonus policies quite differently. We categorize and formally present the most common PLI bonus distribution mechanisms. These bonus models closely mirror the Danish, German, British, and Italian regulatory framework. Subsequently, we perform a comparative analysis of the different bonus models with regard to risk valuation. We calibrate contract parameters so that the compared contracts have a net present value of zero and the same safety level as the initial position, using risk-neutral valuation. Subsequently, we analyze the effect of changes in the asset volatility and in the initial reserve amount (per contract) on the value of the default put option (DPO), while keeping all other parameters constant. Our results show that DPO values obtained with the PLI bonus distribution model of Bacinello (2001), which replicates the Italian regulatory framework, are most sensitive to changes in volatility and initial reserves.