The conversion option in life insurance

This paper introduces an option that has been provided by life insurance companies extensively but has not been discussed in much in the literature: the conversion option. By constructing a valuation model, we first confirm that the conversion option may have positive values. We further find that the value of this option highly depends on the difference of the expected and actual mortality pattern after the insured individual converts his/her policy. Meanwhile, considering the general trend of mortality improvement, we incorporate this trend by applying the Lee-Carter model, hoping to provide a reasonable and fair valuation of the conversion option. (C) 2009 Elsevier B.V. All rights reserved.