Lapse-and-Reentry in Variable Annuities

Section 1035 of the current U.S. tax code allows policyholders to exchange their variable annuity policy for a similar product while maintaining tax-deferred status. When the variable annuity contains a long-term guarantee, this “lapse-and-reentry” strategy allows the policyholder to potentially increase the value of the embedded guarantee. We show that for a return-of-premium death benefit guarantee this is frequently optimal, which has severe repercussions for pricing. We analyze various policy features that may help mitigate the incentive to lapse and compare them regarding the insurer's average expense payments and their posttax utility to the policyholder. We find that a ratchet-type guarantee and a state-dependent fee structure best mitigate the lapse-and-reentry problem, outperforming the typical surrender schedule. Further, when accounting for proper tax treatment, the policyholder prefers a variable annuity with either of these three policy features over a comparable stock investment.

This is the peer reviewed version of the following article: [Lapse‐and‐Reentry in Variable Annuities. Journal of Risk and Insurance 85, 4 p911-938 (2016)], which has been published in final form at https://doi.org/10.1111/jori.12171. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Use of Self-Archived Versions: https://authorservices.wiley.com/author-resources/Journal-Authors/licensing/self-archiving.html#3.

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Work Title Lapse-and-Reentry in Variable Annuities
Access
Open Access
Creators
  1. Thorsten Moenig
  2. Nan Zhu
Keyword
  1. Variable annuities
  2. Guaranteed minimum death benefit
  3. Lapse-and-reentry
  4. Policyholder behavior
  5. State-dependent fee
License In Copyright (Rights Reserved)
Work Type Article
Publisher
  1. Journal of Risk and Insurance
Publication Date December 6, 2016
Publisher Identifier (DOI)
  1. https://doi.org/10.1111/jori.12171
Deposited November 22, 2023

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  • Created
  • Added MoenigZhu_LapseReentryVA_WP_May2016-1.pdf
  • Added Creator Thorsten Moenig
  • Added Creator Nan Zhu
  • Published
  • Updated Keyword Show Changes
    Keyword
    • Variable annuities, Guaranteed minimum death benefit, Lapse-and-reentry, Policyholder behavior, State-dependent fee