Lapse and Reentry in Variable Annuities

Moenig, Thorsten; Zhu, Nan

doi:10.2139/ssrn.2503995

Cited by 7 publications

(23 citation statements)

References 25 publications

(32 reference statements)

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“…Currently, VA providers charge a “time‐invariant” base fee (formally, the “mortality and expense risk charge” and the “administration charge”) in order to recover their expenses over the duration of the policy. The high level of this fee is a consequence of the large policy acquisition expenses (e.g., commissions), in combination with frequent policy lapses (Paris, ), which give providers less time to recover their up‐front expenses (Pinquet, Guillen, and Ayuso, ; [Moenig and Zhu], ). We demonstrate that a partial front‐loading of the fees can potentially reduce lapses by rewarding and encouraging long‐term consumer participation in the policy.…”

Section: Introductionmentioning

confidence: 99%

“…This would increase the guaranteed amount to the current VA account value, without changing any of the other contract parameters. Moenig and Zhu () show that this “lapse‐and‐reentry” strategy—known commonly as a “1035 exchange”—is frequently optimal and persists even in the presence of a typical VA surrender fee schedule. The strategy is quite costly, though, as the policyholder's market reentry constitutes the sale of a new policy.…”

Section: Introductionmentioning

confidence: 99%

See 1 more Smart Citation

Where Less Is More: Reducing Variable Annuity Fees to Benefit Policyholder and Insurer

Bernard¹,

Moenig²

2018

J of Risk & Insurance

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In the United States, variable annuities (VAs) are popular long‐term personal investment vehicles. Recently, however, sales have begun to dwindle. In fact, financial advisers have long argued against investing in VAs due to the products’ high fees. VA providers charge these fees—typically at a constant rate throughout the policy period—to cover their expenses and the costs of embedded guarantees, and lowering this constant fee rate could make the VA unprofitable. Instead, we propose and analyze a simple change to the fee “structure” that would lower fee rates overall (and thus make the product more attractive to investors) without reducing the insurer's profit. The key insight is that this time‐dependent fee rate (with moderate front‐loading) implicitly discourages policy lapses and exchanges, which reduces the providers’ policy acquisition expenses. Taking into account financially optimal lapse (and reentry) decisions, we determine the optimal timing and rate of the fee reduction for a competitive as well as for an innovative VA provider. An important characteristic of this feature is that it can be implemented easily and effectively to both new and existing VA policies.

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Section: Introductionmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

Where Less Is More: Reducing Variable Annuity Fees to Benefit Policyholder and Insurer

Bernard¹,

Moenig²

2018

J of Risk & Insurance

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“…Specifically, they show that when accounting for taxation, PH withdraws less frequently than without taxes and by employing ordinary pricing techniques, one can obtain prices which are in line with empirical observations. Moreover, Moenig and Zhu (2018) observe that the preferential tax treatment has been one of the key factors that have made Variable Annuities such a popular instrument and thus correctly modeling taxation can improve the explanation of the still unclear mechanisms about these products. We stress out that the investigations in Moenig and Bauer (2016) and Moenig and Zhu (2018) have been performed by assuming the Black-Scholes model for the underlying fund.…”

Section: Introductionmentioning

confidence: 99%

“…In this paper, we present an investigation about GMWB pricing and PH behavior when both tax treatment and stochastic interest rate are considered. In particular, following Moenig and Bauer (2016) and Moenig and Zhu (2018), we model taxation of GMWB through a constant marginal income tax rate on all policy earnings and a constant marginal tax rate on capital gains from investments outside of the policy. Moreover, we also include a premium-based model for taxation of the insurer, which was neglected in previous researches.…”

Section: Introductionmentioning

confidence: 99%

Taxation of a GMWB Variable Annuity in a Stochastic Interest Rate Model

Molent

2020

ASTIN Bull.

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Modeling taxation of Variable Annuities has been frequently neglected, but accounting for it can significantly improve the explanation of the withdrawal dynamics and lead to a better modeling of the financial cost of these insurance products. The importance of including a model for taxation has first been observed by Moenig and Bauer (2016) while considering a Guaranteed Minimum Withdrawal Benefit (GMWB) Variable Annuity. In particular, they consider the simple Black–Scholes dynamics to describe the underlying security. Nevertheless, GMWB are long-term products, and thus accounting for stochastic interest rate has relevant effects on both the financial evaluation and the policyholder behavior, as observed by Goudenège et al. (2018). In this paper, we investigate the outcomes of these two elements together on GMWB evaluation. To this aim, we develop a numerical framework which allows one to efficiently compute the fair value of a policy. Numerical results show that accounting for both taxation and stochastic interest rate has a determinant impact on the withdrawal strategy and on the cost of GMWB contracts. In addition, it can explain why these products are so popular with people looking for a protected form of investment for retirement.

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“…However, we find that these minimal surrender penalties are generally too high to lead to a marketable VA product. To address this issue, we consider the state‐dependent fee structure introduced by Bernard, Hardy, and MacKay (), where the fee is paid to the insurer only when the account value is below a certain threshold (see also Delong, ; Moenig and Zhu, ; Zhou and Wu, ) 5 . The motivation is the following: since the state‐dependent fee structure reduces the incentive to lapse the VA contract, it can be combined with smaller surrender charges to achieve our goal of removing the surrender incentive.…”

Section: Introductionmentioning

confidence: 99%

Risk Management of Policyholder Behavior in Equity‐Linked Life Insurance

MacKay¹,

Augustyniak²,

Bernard³

et al. 2015

J of Risk & Insurance

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The financial guarantees embedded in variable annuity contracts expose insurers to a wide range of risks, lapse risk being one of them. When policyholders' lapse behavior differs from the assumptions used to hedge variable annuity contracts, the effectiveness of dynamic hedging strategies can be significantly impaired. By studying how the fee structure and surrender charges affect surrender incentives, we obtain new theoretical results on the optimal surrender region and use them to design a marketable contract that is never optimal to lapse.

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Lapse and Reentry in Variable Annuities

Cited by 7 publications

References 25 publications

Where Less Is More: Reducing Variable Annuity Fees to Benefit Policyholder and Insurer

Where Less Is More: Reducing Variable Annuity Fees to Benefit Policyholder and Insurer

Taxation of a GMWB Variable Annuity in a Stochastic Interest Rate Model

Risk Management of Policyholder Behavior in Equity‐Linked Life Insurance

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