FIN358: An insurance company has approached your team seeking advice on what should be done in order to manage the risk from two new products: Fixed Income and Derivative Securities Assignment, SUSS

An insurance company has approached your team seeking advice on what should be done in order to manage the risk from two new products they intend to launch: a 20-year endowment with a 5-year premium payment term and regular payouts from the second year, and a 25-year annuity with a 4-year premium payment term and regular payouts from the 21st year. Both offer a guaranteed lump sum payment at maturity in addition to projections at two different nonguaranteed rates.

Your task is to present to the company the strategies that can be employed in order to meet the liabilities of offering the following products:

Policy A:

Maturity
20 years

Premium Payment Term
  5 years

Annual Premium
S$10,003

Coupon from Year 2 Onward
S$  1,500

Redemption Upon Maturity
 

  Guaranteed
S$25,832

  Non-Guaranteed at 3.00%
S$39,958

  Non-Guaranteed at 4.25%
S$48,101

Policy B:

Maturity
25 years

Premium Payment Term
  4 years

Annual Premium
S$10,004

Monthly Payment from Year 21
S$     780

Redemption Upon Maturity
 

  Guaranteed
S$     260

  Non-Guaranteed at 3.00%
S$  2,666

  Non-Guaranteed at 4.25%
S$  2,782

In your report, you may wish to consider the following questions:

1.      Describe and comment on the characteristics of the above policies (IRR, Duration, Convexity)

2.      Construct a portfolio to approximately replicate the cash flows of each of the policies

3.      Compare between the two portfolios and comment on which is easier for you to construct

4.      Now consider the case where you have to replicate a portfolio that contains both the policies

5.      How would you go about trying to profit off the above policies? Describe your strategy and the risks associated with it

6.      Comment on how this strategy would change if upon the death of the policyholder, a benefit of premiums compounded at the different non-guaranteed rates are payable

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