Hedging Insurance Books

Abstract

Complex insurance risks typically have multiple exposures. Options on multiple underliers with a short maturity are employed to hedge this exposure. Hedges are illustrated for GMWBVA accounts invested in the nine sector ETF's of the US economy. The underliers are simulated risk neutrally by writing them as transformed correlated normals. The underlying physical and risk neutral evolution is taken in the variance gamma class as a simple example of a non-Gaussian limit law. Insurance accounts for GMWBVA's are simulated and the present value of aggregate payouts is hedged using least squares, ask price minimization and ask price minimization constrained to long only option positions. The last of these delivers a least cost and most stable result.

Keywords: Acceptable Risks, Probability Distortions, Variance Gamma Model

JEL Classification: G13, G17, G22