The alternative pricing approach for variable life insurance incorporating secondary life insurance market

Authors: Lieh-Ming Luo; Her-Jiun Sheu;

Journal: Chia Da Management Review. Jun. 2009, 29(1): 79-101.

Keywords: Variable life insurance; Option pricing approach; Secondary life insurance market

Abstract:
One distinguishing feature of variable life insurance policy is that the benefit payable at expiration depends on the market value of the linked reference portfolio as contrasted with traditional life insurance policies. The conventional pricing approach combines traditional law of large number considerations and financial mathematics. Subsequent relevant studies follow such the valuation approaches. Because recently secondary life insurance markets in America are developing and growing rapidly, liquidity of life insurance contracts has significantly improved. So life insurance contracts could not only be guarantees against losses, but also could be seen as tradable portfolio assets. This market characteristic could serve an extra condition for the application of option pricing model to the valuation of variable life insurance. In this article, in comparison with the conventional pricing approaches for variable life insurance, an alternative valuation method is developed with pure option pricing approach especially incorporating the secondary life insurance market. The conventional valuation approach and its properties are reviewed and its derived price is proved as a special one with respect to a specific risk-neutral probability measure in the present valuation framework. Numerical analysis illustrates the relationship between no-arbitrage price bounds and the conventional pricing approach as well. The results indicate that no-arbitrage bounds of the insurance contract would be influenced by asset price volatility, risk-free rate and mortality pattern in different directions, and particularly would be augmented with liquidity risk premium in the secondary life insurance market.