Scandinavian Working Papers in Economics

Working Papers,
Copenhagen Business School, Department of Finance

No 2000-1: Paying for minimum interest rate guarantees: Who should compensate who?

Bjarne Astrup Jensen and Carsten Sørensen
Additional contact information
Bjarne Astrup Jensen: Department of Finance, Copenhagen Business School, Postal: Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark
Carsten Sørensen: Department of Finance, Copenhagen Business School, Postal: Department of Finance, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark

Abstract: De ned contribution pension schemes and life insurance contracts often have a minimum interest rate guar- antee as an integrated part of the contract. This guarantee is an embedded put option issued by the institution to the individual, who is forced to hold the option in the portfolio. However, taking the inability to short this saving and other institutional restrictions into account the individual may actually face a restriction on the feasible set of portfolio choices, hence be better o without such guarantees. We measure the e ect of the minimum interest guarantee con- straint through the wealth equivalent and show that guar- antees may induce a signi cant utility loss for relatively risk tolerant investors. We also consider the case with heterogenous investors sha- ring a common portfolio. Investors with di erent risk atti- tudes will experience a loss of utility by being forced to share a common portfolio. However, the relatively risk averse in- vestors are partly compensated by the minimum interest rate guarantee, whereas the relatively risk tolerant investors are su ering a further utility loss.

Keywords: Minimum interest rate guarantee; asset allo- cation restrictions; utility loss; wealth equivalent; heteroge- nous investors.

JEL-codes: G11; G13

31 pages, January 12, 2000

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