Pricing Approaches for Guaranteed Annuity Options

The payout from many insurance contracts depends in some way upon the actual investment return earned on the assets subject to some minimum guarantee. Payouts may depend on the investment return in one of two ways. First, with unit-linked policies, the payout is directly linked to the performance of the underlying assets. Second, with participation policies, policy owners share the profits of the insurer. The full effect of the investment return is not immediately credited to participating policies. Rather, a series of bonuses is declared which will smooth the return credited to the policies. The guarantee of returns may be structured in a variety of ways. The most common structural forms are as follows:

1. Maturity Guarantee: In a maturity guarantee, the return is guaranteed on maturity of the policy. A return is not guaranteed in the case of an early surrender of the policy.

2. Surrender Guarantee: In a surrender guarantee structure, the guaranteed policy value can be claimed by the policy holder at any time up to and including maturity. The guaranteed amount tends to increase as the time of surrender approaches the policy term.

3. Guaranteed Annuity Option: With a guaranteed annuity option, the payout at ma

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