Embedded Options - Building bridges

This paper investigates how the guarantees embedded within long-term savings contracts can be recast as derivatives contracts, and discusses the practical implications and limitations of using the derivatives market to hedge guarantees. By gary steele finkelstein, andrew michael brogden and juan carlos esparragoza rodriguez

Competition for consumer savings is causing an increasing proliferation of guaranteed benefits, or in other words, embedded options, within savings contracts. Changing economic events, attitudes of regulators and international financial reporting standards are causing the spotlight to focus on these embedded options. In order to compete effectively for new business, it is becoming increasingly important for life insurance companies to be able to price and manage the risk inherent in the embedded