On the Propensity to Surrender a Variable Annuity Contract: An Empirical Analysis of Dynamic Policyholder Behavior

Abstract

We empirically analyze surrender behavior for variable annuity contracts using Japanese individual policy data. For traditional life insurance products, surrender behavior is typically explained by the interest rate and the emergency fund hypotheses. For variable annuities, the interest rate hypothesis is not directly applicable. For these products, we expect the value of the financial options and guarantees provided to the policyholder to drive surrender behavior. We define this expectation as the "moneyness hypothesis." The statistical analysis confirms our moneyness hypothesis: the value of the embedded financial options and guarantees has the largest explanatory power for the surrender rate. The extent to which this finding holds depends on the single premium paid, which we consider a proxy for the policyholder's financial literacy. Moreover, our data set weakly supports the emergency fund hypothesis for the case of variable annuities.

A Unified Pricing of Variable Annuity Guarantees under the Optimal Stochastic Control Framework

“…Thus the development of secondary markets for VA riders would lead to an increase in the fees charged by the issuing companies. [18] undertakes an empirical study of policyholders behavior in Japanese VA market and they show that the moneyness of the guarantee has the largest explanatory power for the surrender rates.…”

“…Thus, third parties can potentially generate a guaranteed profit through hedging strategies from the financial products such as VA riders which are not priced under the assumption of the optimal withdrawal strategy. The authors of [18] mention several companies recently suffering large losses related to increased surrender rates, indicating that either the charged fees were not sufficiently large or that the hedging program did not perform as expected.…”

Incorporation of Stochastic Policyholder Behavior in Analytical Pricing of GMABs and GMDBs

“…Therefore, there is a significant incentive for the insured person to cancel the contract and potentially enter a new one with a higher guaranteed value. Empirical evidence for this hypothesis is given, for example, in [5,12]. The former paper also tests and supports interest-rate and emergency fund hypotheses in the context of variable annuities.…”

“…Modeling policyholder risk should deserve special attention, as "it has influence on the pricing of the options and guarantees within the contracts, on solvency capital requirements, and hedging effectiveness" [5]. High losses have been reported by VA carriers due to changes in surrender assumptions (Mountain Life reported an increase in the value of its liabilities by USD 48 bn due to a reduction of assumed surrender rates 1 ).…”

“…The former paper also tests and supports interest-rate and emergency fund hypotheses in the context of variable annuities. According to the company surveys conducted by [5,13] as well as shown in some examples of [7], policyholders do not always act rationally. They cancel their products even when it is not economically rational 2 and also do not surrender their guarantees deep out of the money.…”