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Understanding the Death Benefit Switch Option in Universal Life Policies
Author(s) -
Gatzert Nadine,
SchmittHoermann Gudrun
Publication year - 2011
Publication title -
journal of risk and insurance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.055
H-Index - 63
eISSN - 1539-6975
pISSN - 0022-4367
DOI - 10.1111/j.1539-6975.2010.01386.x
Subject(s) - actuarial science , life insurance , valuation (finance) , insurability , option value , economics , value (mathematics) , present value , cash , business , insurance policy , public economics , incentive , microeconomics , general insurance , computer science , finance , insurance law , machine learning
Abstract Universal life policies are the most popular insurance contract design in the United States. They provide either a level death benefit paying a fixed face amount or an increasing death benefit paying a fixed benefit plus the available cash value, and both types include the option to switch from one type to the other. In this article, we investigate the fact that—unlike a switch from level to increasing—a switch from an increasing death benefit to a level death benefit requires neither fees nor evidence of insurability. To assess the impact of the death benefit switch option, we develop a model framework of an increasing universal life insurance policy embedding this option. Consideration of heterogeneity with respect to mortality via a stochastic differential mortality factor enables an investigation of adverse exercise behavior. In a comprehensive simulation analysis, we quantify the net present value of the option from the insurer's perspective using risk‐neutral valuation under stochastic interest rates assuming empirical exercise probabilities. Based on our results, we provide policy recommendations for life insurers.