Section 1035 of the current U.S. tax code allows policyholders to exchange their variable annuity policy for a similar product while maintaining tax‐deferred status. When the variable annuity contains a long‐term guarantee, this “lapse‐and‐reentry” strategy allows the policyholder to potentially increase the value of the embedded guarantee. We show that for a return‐of‐premium death benefit guarantee this is frequently optimal, which has severe repercussions for pricing. We analyze various policy features that may help mitigate the incentive to lapse and compare them regarding the insurer's average expense payments and their posttax utility to the policyholder. We find that a ratchet‐type guarantee and a state‐dependent fee structure best mitigate the lapse‐and‐reentry problem, outperforming the typical surrender schedule. Further, when accounting for proper tax treatment, the policyholder prefers a variable annuity with either of these three policy features over a comparable stock investment.

No abstract

The paper presents a review of structural models of policyholder behavior in life insurance.We first discuss underlying drivers of policyholder behavior in theory and survey the implications of different models. We then turn to empirical behavior and appraise how well different drivers explain observations. The key contributions lie in the synthesis and the systematic categorization of different approaches. The paper should provide a foundation for future studies, and we describe some important directions for future research in the conclusion.

No abstract

Although life settlements are advertised to deliver a profitable investment opportunity with a low correlation to market systematic risk, recent investigations reveal a discrepancy of expected and realized returns. While thus far this discrepancy has been attributed to the (allegedly) poor quality of the underlying life expectancy estimates, we present a different explanation of the seemingly high reported expected returns based on adverse selection. In particular, we provide a coherent pricing mechanism and pricing formulas in the presence of asymmetric information with respect to the underlying life expectancies. Therefore, our study sheds light on the nature of the "unique risks" within life settlements as recently discussed in the financial press. Nan Zhu is at the