Hedging of Long-term Fund-linked Exotic Options
Laurent Bourlard
Low Interest Rate Environments and Consequences
Risks Faced by Writers of Investment Guarantees
Variable Annuity in Asia post-2008
How did Variable Annuities Fare in the Crisis?
Traditional Life Insurance Products are Under Pressure
An Overview of Regulatory Requirements
Simulations
Economic Scenario Generators and Variable Annuities
Modelling and Managing Policyholder Behavioural Risks
Modelling and Managing Mortality and Longevity Risks
Valuation of Variable Annuity Guarantees
Understanding and Using Reinsurance Treaties for Guaranteed Products
Hedging of Long-term Fund-linked Exotic Options
Overview of Commonly Used Risk Management Strategies
Taxonomy of Equity, Interest Rate, Hybrid and Customised Derivatives Used for Risk Management
Managing Risks Underlying Variable Annuity Liabilities
Basis Risk
Measuring Hedge Effectiveness
Measuring and Reporting Hedge Efficiency
Eight Important Questions Practitioners Should Ask When Managing Equity-linked Insurance Guarantee Risks
This chapter will cover three key areas concerning the hedging of long-term fund-linked exotic options, starting with illustrative examples that stress the extent to which a long-term option on funds can be defined as “exotic”. It will then describe the main milestones on the road to a hedging strategy: risk mapping; risk appetite; and subsequently a hedging strategy associated with each risk identified. Finally, we will describe the foremost hedging strategies – static, dynamic and reinsurance – that are the building blocks for a comprehensive approach to hedging the various risks embedded in long-term options with funds as underlying.
The product to be analysed in this chapter is a unit-linked product with guarantees. Guarantees can take the form of capital guarantee, guaranteed income for a given maturity (for instance, 5% for 20 years) or guaranteed income for life. All these payouts provide various features that characterise them as exotic.
WHY CALL LONG-TERM FUND-LINKED OPTIONS WITHIN A LIFE PRODUCT “EXOTIC”?
The hedging strategy is one of the key elements of product design when it comes to unit-linked products with guarantees. The risk management challenges implied by
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