Assessing the Risk Potential of Premium Payment Options in Participating Life Insurance Contracts

Most life insurance contracts embed the right to stop premium payments during the termof the contract (paid-up option). Thereby, the contract is not terminated but continueswith reduced benefits and often provides the right to resume premium payments later,thus increasing the previously reduced benefits (resumption option). In our analysis, westart with a basic contract with two standard options, namely, an interest-rate guaranteeand annual surplus participation. Next, in addition to the features of the basic contract, apaid-up and resumption option is included in the framework. The valuation process is notbased on assumptions about a particular policyholders’ exercise strategy, but instead assessesthe risk potential from the insurer‘s viewpoint by providing an upper bound forany possible exercise behavior. This approach provides important information to the insurerabout the potential hazard of offering the paid-up and resumption option. Further,the approach allows an analysis of the impact of guaranteed interest rate, annual surplusparticipation, and investment volatility on the values of the premium payment options.