Fair Valuation of Embedded Options in Participating Life Insurance Policies

Participating life insurance contracts are characterized by a minimum interest rate guarantee and pay dividends to its policyholder based on how well the issuing company is doing. These contracts are endowments that contain implicit options-like features such as minimum interest rate guarantees, stochastic annual surplus participation, terminal bonus and a surrender option. The stable returns are obtained through the combination of guaranteed benefits and non-guaranteed bonuses that are paid to the policyholders. In the existing literature the options are priced under strong assumptions, such as constant interest rates, and only take univariate risk factors, such as stochastic stock prices, into account. In this thesis, we investigate the impact of the term structure, the long-term investment, the price inflation, the mortality, the surrender behavior and the implication of multivariate risk on the fair pricing of the single premium life insurance policy. The fair contract can be priced by applying risk-neutral valuation methods and Monte Carlo simulation. Keywords: Participating life insurance contract; Risk-neutral valuation; Embedded option, Bonus distribution; Interest rate risk; Inflation risk; Lee-Carter mortality model; Surrender option; Multivariate risk; Monte Carlo simulation.