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Should I stay or go? Valuation of multiple premium payment options for participating life insurance contracts

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  • Hsiaoyin Chang

    (University of St. Gallen)

  • Hato Schmeiser

    (University of St. Gallen)

Abstract

Participating life insurance contracts with investment guarantees typically possess various embedded options. In this paper, we focus on common options with early exercise features, i.e., paid-up options, resumption options, surrender options and the combinations among them. The valuation of these options depends strongly on the exercise strategy applied by the policyholder. We extend the Least Square Monte Carlo (LSMC) method to approximate an optimal exercise strategy and to determine multiple optimal exercise points while incorporating two stochastic sources (asset and interest rate risk). In addition, these findings are compared to results based on two other exercise assumptions. In contrast to earlier studies on this topic, we show in our model setup that premium-payment options can pose a severe risk for life insurers if not priced properly and hence are of great value for policyholders if used strategically. Moreover, we demonstrate that introducing fees for exercising premium-payment options only slightly reduces the option price necessary to finance adequate risk management measures.

Suggested Citation

  • Hsiaoyin Chang & Hato Schmeiser, 2025. "Should I stay or go? Valuation of multiple premium payment options for participating life insurance contracts," Review of Managerial Science, Springer, vol. 19(10), pages 3039-3072, October.
    • Handle: RePEc:spr:rvmgts:v:19:y:2025:i:10:d:10.1007_s11846-025-00841-w
    DOI: 10.1007/s11846-025-00841-w
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    JEL classification:

    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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