RESERVING FOR MATURITY GUARANTEES - 2 APPROACHES

This paper examines the pricing of and reserving for certain guarantee s that are associated with some insurance contracts. Specifically we d eal with maturity guarantees, which provide a minimum level of benefit s at contract maturity. Under these contracts the policyholders' premi ums are invested in a specified portfolio, When the contract matures t he value of the benefit is guaranteed not to fall below a certain leve l. We examine and contrast two approaches to the pricing and reserving for these guarantees. The first approach is based on stochastic simul ation of future investment returns. The second approach is based on mo dern option pricing theory. The reserving procedures under the two app roaches differ dramatically. We provide numerical estimates of the res erves required under each approach using realistic assumptions. We fin d that the conventional option hedging strategies in the presence of t ransaction costs become relatively expensive. (C) 1997 Elsevier Scienc e B.V.