“A lattice model for pricing equity linked policies with embedded surrender options”

We propose a lattice based model for computing the fair premiums of equity-linked policies with embedded surrender options. By considering the case of periodical deemed contributions invested in the reference fund, the premium evaluation problem becomes computationally unmanageable since the lattice describing the evolution of the reference fund is not recombining. Consequently, at each node of the tree describing the dynamics of the equity value, we have huge sets of reference fund values to take into account. The algorithm overcomes this obstacle by considering sets of “representative” values for the reference fund instead of all the possible ones associated to each node of the tree describing the evolution of the equity value. This allows us to define a simple and efficient method to compute the fair periodical premiums.