Valuation of with-profit insurance policies with interest rate guarantees
Classical with-profit life insurance products are traditionally backed by a buy-and-hold bond investment strategy. Using book-value accounting for such products tends to lead to a design of the guarantee rate based on an average of long-term interest rates. When such a link is hardwired into the bonus mechanism, the sensitivity to interest rate volatility becomes significant on an arbitrage free mark-to-market valuation basis, which traditional investment strategies fail to account for.
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