Valuation of Variable Annuity Guarantees

Kirk Evans

As seen in the preceding chapters, variable annuity (VA) products contain elements that are similar to capital market options and those similar to traditional insurance products. This dual nature needs to be considered when valuing VA guarantees. Only then can we gain an accurate assessment of the risk VA guarantees impose to the seller, and thus be able to determine the appropriate charge for VA guarantees.

In this chapter, the focus will be on the guarantee elements of VA products. The VA guarantee’s similarity to capital market options derive from the fact that its value is tied asymmetrically to the VA’s underlying fund performance. Most VA guarantees (guaranteed minimum death benefit, GMDB; guaranteed minimum income benefit, GMIB; guaranteed minimum accumulation benefit, GMAB; guaranteed minimum withdrawal benefit, GMWB; and guaranteed lifetime withdrawal benefit, GLWB) are similar to capital market put options, and provide a payout to the VA guarantee holder if the performance of the underlying funds (net of fees) does not meet some minimum level of return over a specified period of time. However, there are some less popular VA guarantees, such as the enhanced earnings