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Risk.net
Insurance quants increase risk-adjusted profits using novel hedging technique
But there is no standard way for insurance companies to hedge the risk of variable annuity contracts.
Two industry practitioners have put forward a new hedging method using protective put options. They estimate that the technique can improve risk-adjusted profits for insurers’ variable annuity portfolios by 60%.
The improvement comes from two sources: more efficient use of options as a hedging tool, and a reduction in the capital charges for insurers.
The approach is based on the assumption that a variable annuity can technically be seen as an option on the future value of the premiums. “The liabilities can be modelled as long-dated options and we use short-dated put options to hedge them. And we are framing how to calculate that hedge and optimise capital requirements,” explains Vivek Shah, who oversees investment and hedging solutions at Prudential plc in London. Shah ....

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