Valuation of insurance contract options
Abstract
The note first shows where options and guarantees can occur in life insurance products and why it is important to consider them. Two explicit valuation approaches for options and guarantees are presented: one from option pricing theory and one from the Solvency II environment or Market Consistent Embedded Value (MCEV). We present these two approaches and compare them. The comparison is carried out both in a theoretical single-period model and in practice using two examples. Since simulation calculations based on a company model are usually necessary for the specific calculation, this note also discusses the basic principles of company models. Since an explicit calculation of the values of options and guarantees is often numerically very complex, two possible approximation methods are presented.
The material scope of this paper covers life insurance companies. Pursuant to Section 4 (6) of the Actuarial Regulation, the responsible actuary must comment on the valuation of options embedded in the insurance, at least insofar as provisions for imminent losses are concerned. Within Solvency II, technical provisions must be valued taking into account the options and guarantees embedded in the contracts. Options and guarantees should also be taken into account in any valuation of life insurance obligations that involve capital market risks.
