Pricing and dynamic hedging strategies for a bond-linked life insurance policy with a guarantee

Variable life insurance (VL) has gained great popularity for its fluctuating but minimum guaranteed death benefit under the high level of inflation in the late 1970's. It also offers policyowner a choice of vehicles in which the cash value can be invested. The risk from the death value guarantee is systematic and thus may jeopardize the financial soundness of the insurer unless proper pricing and investment strategies are adopted.Utilizing the recently developed pricing models of interest rate contingent claims, this thesis determines the equilibrium charge for the death benefit guarantee of VL when the policyowner chooses to invest the cash value in a bond market. Dynamic hedging strategies under a stochastic interest rate environment are also developed, which can eliminate or reduce the investment risk stemming from the minimum death value guarantee. Application of the proposed strategies would have the effect of reducing the volatility of earnings for VL insurers and lowering the probability and size of catastrophic losses.U of I OnlyETDs are only available to UIUC Users without author permissio