Practical Financial Optimization: Decision Making for Financial Engineers

Chapter 12

Insurance Policies with Guarantees

With Andrea Consiglio,¹Flavio Cocco,² and David Saunders³

12.1 Preview

Insurance products have become increasingly more innovative in order to face competitive pressures. Insurance policies today come with guarantees on the minimum rate of return, bonus provisions, and surrender options – features that make the new policies much more complex to price and fund than traditional insurance products. In this chapter we discuss the development of scenario-based optimization models for asset and liability management of participating policies with guarantees and bonus provisions offered by Italian and UK insurers. The developed models are applied to the analysis of policies offered by both Italian and UK insurance firms. Numerical investigations with the models provide significant insights on these policies.

12.2 Participating Policies with Guarantees

The last decade brought about a phenomenal increase of consumer sophistication in terms of the financial products they buy. This trend is universal among developed economies, from the advanced and traditionally liberal economies of North America, to the increasingly deregulated economies of the European Union and pre-accession States, and the post-Communist countries.

The numbers are telling: In the 1980s almost 40% of US consumer financial assets were in bank deposits. By 1996 bank deposits accounted for less than 20% of consumers' financial assets, with mutual funds and insurance and pension ...