Investment policy for unit-linked guarantees

[lionking]

Hi there

I hope someone can help. I have a question from Chapter 11, page 14 of SA6.

The core reading says that the excess of the sum assured over the unit value should be considered a fixed liability.

Doesn't the value of the liability change depending on the unit price? In other words, if the unit price rises, then the value of the liability must fall, because the company only has to make up a smaller difference between the guaranteed minimum SA and the unit value.

If that is the case, then what kind of an investment policy should one follow to match those liabilities? Is it right to think of it as a fixed liability?

 

[Colin McKee]

Chapter 11 fixed liabilities

I see where you are coming from. The liability will indeed change with changing unit prices. My interpretation is that the liability is not "real" in nature, in that it will not grow in line with inflation. But "fixed" probably doesnt mean set in stone.
So it is an uncertain liability that can move up or down in line with the markets, going up when markets fall. It is also a liability that will only be paid on death. Hmm tricky one to develop an investment strategy for. I would imagine that life offices dont try anything fancy and simply make a best estimate of the liability of the whole portfolio of policies and hedge with bonds.
Anyone know otherwise?

 

[Gareth]

I would imagine it is best hedged using derivatives, i.e.

liab = max( unit value_t - Sum Assured, 0)

So going long in an American call on a basket of equities (or whatever broadly matches the unit fund) should leave you risk neutral (i think)...

[edit] or you could hedge by creating an synthetic call