A joint valuation of premium payment and surrender options in participating life insurance contracts

In addition to an interest rate guarantee and annual surplus participation, life insurance contracts typically embed the right to stop premium payments during the term of the contract (paid-up option), to resume payments later (resumption option), or to terminate the contract early (surrender option). Terminal guarantees are on benefits payable upon death, survival and surrender. The latter are adapted after exercising the options. A model framework including these features and an algorithm to jointly value the premium payment and surrender options is presented. In a first step, the standard principles of risk-neutral evaluation are applied and the policyholder is assumed to use an economically rational exercise strategy. In a second step, option value sensitivity on different contract parameters, benefit adaptation mechanisms, and exercise behavior is analyzed numerically. The two latter are the main drivers for the option value.

► Paid-up, resumption and surrender options in life insurance contracts are considered. ► Guaranteed benefits upon death, survival and surrender are adapted after option exercise. ► Model and algorithm to jointly value the options is developed and illustrated. ► Different valuation approaches including rational optimal strategy are compared. ► Sensitivity on contract parameters, benefit adaptation, exercise behavior is analyzed.