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The Pricing for Interest Sensitive Products of Life Insurance Firms

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Author(s): James C. Hao

Journal: Modern Economy
ISSN 2152-7245

Volume: 02;
Issue: 03;
Start page: 194;
Date: 2011;
Original page

Keywords: Cash Flow Analysis | Interest Sensitive Annuity | Arbitrage Free Interest Rate Model | Optional-Adjusted Spread Analysis Model

ABSTRACT
The major purpose of this paper is to construct interest rate risk models for interest sensitive products issued by life insurance firms in Taiwan. With interest declines in late 1990s, single paid interest sensitive annuity takes up about 20% of new policy premiums in Taiwan; this implies its risk and profitability become critical to insurers’ financial health. The paper constructs the Black-Derman-Toy model combining with optional-adjusted spread analysis model to price the spread on asset required to yield to make such products break even, with further extension to measure the impact of interest shock on asset liability management. We choose two different crediting strategy products to illustrate the option value of the insurance firms- the option to reset rates based on the path of interest rates and the expenses charges as well as the option of policyholders-the option to surrender policy if not satisfied with crediting rate. With our implemenTable models, insurance firm will have capacity to quantify its risk exposure and source of profitability as well as to seek an optimal strategy balancing sale volume and aggressiveness of crediting policy.
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