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Optimal allocation and consumption with guaranteed minimum death benefits, external income and term life insurance

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  • Gao, Jin
  • Ulm, Eric R.

Abstract

Because human capital is often the largest asset an investor possesses when he is young, protecting human capital from potential risks should be considered as a part of overall investment advice. The risk of the loss of the policyholder’s human capital–the mortality risk–to the household can be partially hedged by a term life insurance policy. Guaranteed Minimum Death Benefits (GMDB) in Variable Annuities (VA) can also help policyholders hedge the risk of the loss of human capital. Therefore, GMDB options and term life insurance can be considered as substitute goods. However, they are not perfect substitute as GMDB and term life have their own properties: Term life insurance has no correlation with equity markets, and it is purely regarded as a protection for human capital; the variable annuity products follow the performance of equity markets, and the GMDB is a protection against downside risks on equity markets as well as human capital. We find that fairly priced GMDB options fail to add value to a VA contract if a term life policy is available.

Suggested Citation

  • Gao, Jin & Ulm, Eric R., 2015. "Optimal allocation and consumption with guaranteed minimum death benefits, external income and term life insurance," Insurance: Mathematics and Economics, Elsevier, vol. 61(C), pages 87-98.
    • Handle: RePEc:eee:insuma:v:61:y:2015:i:c:p:87-98
    DOI: 10.1016/j.insmatheco.2014.12.004
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    References listed on IDEAS

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    Cited by:

    1. Srbinoski Bojan & Strozzi Fernanda & Poposki Klime & Born Patricia H., 2020. "Trends in Life Insurance Demand and Lapse Literature," Asia-Pacific Journal of Risk and Insurance, De Gruyter, vol. 14(2), pages 1-46, July.
    2. Ulm, Eric, 2020. "Analytic Valuation of GMDB Options with Utility Based Asset Allocation," Working Paper Series 21060, Victoria University of Wellington, School of Economics and Finance.
    3. Huang, Huaxiong & Milevsky, Moshe A., 2016. "Longevity risk and retirement income tax efficiency: A location spending rate puzzle," Insurance: Mathematics and Economics, Elsevier, vol. 71(C), pages 50-62.
    4. Ulm, Eric, 2020. "Analytic Valuation of GMDB Options with Utility Based Asset Allocation," Working Paper Series 8566, Victoria University of Wellington, School of Economics and Finance.
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    More about this item

    Keywords

    GMDB; Variable annuity; Expected utility; CRRA; Bequest motive;
    All these keywords.

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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