Topics in investment insurance for account-based pension

Abstract

In this thesis, we propose and investigate novel investment insurance products for account-based pensions, especially Australian superannuation, which is called the equity protection swap (EPS).

An equity protection swap is a financial derivative, which is reminiscent of a total return swap but also shares some features with the annuity insurance product, RILA. The buyer of an equity protection swap obtains a partial protection against potential losses on a reference portfolio and, in exchange, agrees to share the portfolio’s gains with the provider if the realised return on the reference portfolio is above a predetermined positive level. Formally, the structure of a generic EPS consists of the protection and fee legs with different participation rates with all parameters negotiated by the provider and buyer.

We derive a general model-free pricing formula for a generic equity protection swap by identifying the static hedging strategy based on traded European call and put options. We argue that to make the contract appealing to a holder, the provider should select an appropriate participation rate for the fee leg in relation to the protection level required by the holder so that a fair premium for the contract at its inception date is null.

We further consider the situation that the realised settlement date is later than the nominal maturity of an equity protection swap in order to account for a potential market recovery. To make our results more practical, the cross-currency reference portfolio, time lag between pricing and hedging, market crisis, counterparty default risk, dividends, and inflation are added into the consideration of an equity protection swap. We provide suitable static hedging strategies or super-hedging strategies for each of the considered pricing and hedging problems. We present numerical examples based on market data to demonstrate the benefits of an equity protection swap as an efficient portfolio insurance tool.