The Impact of Management Fees on the Pricing of Variable Annuity Guarantees

Abstract

Variable annuities, as a class of retirement income products, allow equity market exposure for a policyholder’s retirement fund with optional guarantees to limit the downside risk of the market. Management fees andguarantee insurance fees are charged respectively for the market exposure and for the protection from the downside risk. We investigate the pricing of variable annuity guarantees under optimal withdrawal strategies when management fees are present. We consider from both policyholder’s and insurer’s perspectives optimal withdrawal strategies and calculate the respective fair insurance fees. We reveal a discrepancy where the fees from the insurer’s perspective can be significantly higher due to the management fees serving as a form of market friction. Our results provide a possible explanation of lower guarantee insurance fees observed in the market than those predicted from the insurer’s perspective. Numerical experiments are conducted to illustrate the results.

Taxation of a GMWB Variable Annuity in a Stochastic Interest Rate Model

“…Anyway, various academics have postulated more fascinating reasons. For example, Piscopo and Haberman (2011) prove that neglecting randomness of mortality rates can lead to mispricing, while Sun et al (2018) attribute mispricing to the lack of a correct model for management fees. Furthermore, Kling et al (2014) find that the price of the guarantee strongly depends on the considered model for the PH's behavior.…”

Fair Pricing of Variable Annuities with Guarantees under the Benchmark Approach

“…By assuming an optimal policyholder's withdrawal behavior, the pricing of the VA product corresponds to the hedging cost of the worst case scenario faced by the VA provider. In other words, the price of the VA product under the respective dynamic strategy provides an upper bound of hedging cost from the VA provider's perspective; see Sun et al (2018). It should be noted that the actual policyholders' withdrawal strategies could be far from optimal; see, e.g., Moenig and Bauer (2015).…”