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Fair Valuation of Equity-Linked Policies under Insurer Default Risk

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  • Massimo Costabile
  • Ivar Massabò
  • Emilio Russo

Abstract

We consider the problem of computing the fair value of equity-linked policies with an interestrate guarantee when the insurer is subject to credit risk. The framework is developed based on modern financial theory using the no-arbitrage principle. In this context, an equity-linked policy is considered as a vulnerable contingent claim that expires before maturity if the firm asset value reaches a prespecified default threshold depending on the firm’s liabilities. We derive a closedform formula in a continuous-time environment to compute the fair value of the contract. We also develop a discrete-time model that allows us to address fair evaluation when the policy embeds a surrender option.

Suggested Citation

  • Massimo Costabile & Ivar Massabò & Emilio Russo, 2011. "Fair Valuation of Equity-Linked Policies under Insurer Default Risk," North American Actuarial Journal, Taylor & Francis Journals, vol. 15(4), pages 517-534.
    • Handle: RePEc:taf:uaajxx:v:15:y:2011:i:4:p:517-534
    DOI: 10.1080/10920277.2011.10597636
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