Evaluation of surrender option in unitized participating life insurance with default

Both insurer's default risk and insured's surrender events are important factors in pricing unitized participating life insurance. In order to extend the results presented in our earlier research, we suppose that both surrender and default could happen at the end of each insurance year. In this paper, three models are constructed for pricing surrender option with insolvency. An iterative algorithm based on Monte Carlo simulation method is then implemented in order to compute them. The findings are as follows: price of unitized participating life insurance could be badly underestimated without consideration of surrender option, price of which is highly sensitive to some exogenous variables such as volatility. It was also implied that growth in default risk tends to result in growth in value of surrender option.