Modelling the fair value of annuities contracts: the impact of interest rate risk and mortality risk

Ballotta, L., Esposito, G. & Haberman, S. (2006). Modelling the fair value of annuities contracts: the impact of interest rate risk and mortality risk (Report No. Actuarial Research Paper No. 176). London, UK: Faculty of Actuarial Science & Insurance, City University London.

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Abstract

The purpose of this paper is to analyze the problem of the fair valuation of annuities contracts. The market consistent valuation of these products requires a pricing framework which includes the two main sources of risk affecting the value of the annuity, i.e. interest rate risk and mortality risk. As the IASB has not set any specific guidelines as to which models are the most appropriate for these risks, in this note we consider a range of different models calibrated with historical data. We calculate the fair value of the annuity as a portfolio of zero coupon bonds, each with maturity set equal to the date of the annuity payments; the weights in the portfolio are given by the survival probabilities. Moreover, we focus on the additional information provided by stochastic simulations in order to define a suitable risk margin. The nature of the risk margin is one of the main key issues concerning the IASB and Solvency project.

Item Type: Monograph (Working Paper)
Uncontrolled Keywords: annuity contracts, fair value, market value margin, stochastic mortality
Subjects: H Social Sciences > HG Finance
Divisions: Cass Business School > Faculty of Actuarial Science & Insurance > Faculty of Actuarial Science & Insurance Actuarial Research Reports
URI: http://openaccess.city.ac.uk/id/eprint/2308

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