On Surrender and Default Risks

This article examines the impact that surrender risk can have on the default of insurance 4
companies. The companies that we study issue contacts similar to the ones studied earlier in the literature by Briys and de Varenne (2001), Grosen and Jorgensen (2000), or Bernard, Le Courtois and Quittard-Pinon (2005). They are subject to interest rate and default risk; they offer a guaranteed amount plus a bonus indexed on the performance of the underlying portfolio. In this article, we assume in addition that policyholders have the option to surrender. Surrender risk has been extensively studied in an arbitrated market by Bacinello (2001), using trees for the valuations. We deal with surrender risk in another way, assuming policyholders have sets of information and preferences that differ from the ones of financial market agents. In particular, policyholders are supposed to be only partially rational (at least in the financial sense).