25. Surrender values

Question 1

Why are surrender values not paid for term assurances?

Answer 1

1. Low asset shares
2. High risk of selective withdrawals
3. Recoup losses on early lapses when asset share is negative by making some profit on later lapses when asset share is usually positive.
4. Asset shares are volatile, so would be difficult to create a surrender value scale that would treat policyholders fairly
5. Asset shares can be negative at later durations - and/or are likely to be decreasing towards end of policy- would be hard to explain decreasing surrender values to ph

Question 2

Why are surrender values not paid for immediate annuities?

Answer 2

1. Selective withdrawals leaving average mortality of remaining ph to improve
2. May not be allowed by legislation e.g. if used for retirement and there are tax privileges, people may take advantage of tax concessions and use annuities as savings vehicles but not further goverment’s aim to encourage private pension provision

Question 3

What are the principles for calculating surrender values?

Answer 3

Surrender values must:
* Take into account PRE
* At early durations, not appear to low compared with premiums paid, taking into account any projected values given to new policyholders
* At later durations, be consistent with projected maturity values
* Not exceed earned asset shares in aggregate over a reasonable period of time
* Take into account surrender values offered by competitors
* Not be subject to frequent change, unless dictated by financial conditions
* Not be excessively complicated to calculate, taking into account computing power available
* Be capable of being documented clearly
* Avoid selection against insurer

Question 4

What is the auction value?

Answer 4

Value a policy would fetch if the ph were to transfer it as an ongoing policy to someone else

Question 5

Advantage of using auction value to compare surrender value

Answer 5

Independent assessment and likely to be seen as fair by ph

Question 6

Why might auction value not be suitable for company?

Answer 6

• Assumptions for auction balues likely to be different from company’s own assumptions e.g. might be more optimistic
• Value may fluctuate unpredictable, and difficult to determine without offering a policy for sale

Question 7

Two methods of calculating surrender value

Answer 7

• Retrospective method
• Prospecrive method

Question 8

Retrospective method

Answer 8

• Represents earned asset share or an estimate thereof
• Maximum company can pay without making a loss

Question 9

Advantages of retrospective method

Question 10

Disadvantages of retrospective method

Answer 10

• Doesn’t say anything about profit company would have made if contract wasn’t surrendered»_space; not easy to esnure equity with continuing ph or sh
• Could be inconsistent with maturity value
• Could be negative early on
• Can be hard to calculate

Question 11

Retrospective method and meeting the principles

Answer 11

PRE:
* Doesn’t account for future benefits and expected future experience it could produce sv significantly diff from realistic prospective value (likely to be used for auction values)»_space; if compared by ph may lead to reputational risk

Early durations and projected values in literature:
* Asset share will have close relationship to premiums paid less initial expenses, reasonable if ph think initial expense deduction is reasonable.
* If same method is used in product disclosure literature, ph will expect it reasonable for the same thing to be done for actual sv

Competitors:
* Depends on the method of competitors and basis used

Complexity:
* Not too complex if information is available to build earned asset shares or determine suitable parameters if formula is used

Later duration and maturity value:
* Won’t tend to naturity value if guaranteed amount at maturity > asset share

Question 12

Prospective method

Answer 12

Value of future benefits and expenses net of future premiums due, using estimates of future expected investment returns, expenses and mortality experience of surrending ph allowing for the cost of surrender.

Question 13

Prospective method and meeting the principles

Answer 13

• Realistic basis used = sv will represent worth of contract to company. For w/o profits, can quantify how much profit to retain»_space; maintaining equity between continuing ph and sh

Asset share:
* SV might exceed asset share

PRE and early durations:
* Depending on basis, sv might look unreasonable to surrendering ph at early durations

Later durations:
* Will run into maturity value for without-profits contracts

Competition:
* Likelt to be comparable to competitors and auction values as method is the one usually used
* This will depend on the basis

Complexity:
* If basis isn’t complicated, relatively easy to cal as no knowledge of what has occured in the past is needed

Question 14

What is the challenge with using the retrospective value throughout the term of a policy?

Answer 14

• If using formula, might be hard to find right combination of parameters to produce SV that run into maturity value

Question 15

What is the challenge with using the prospective value throughout the term of a policy?

Answer 15

• Difficult to decide on appropriate interest rate especially at short durations with long outstanding term as small changes in interest rate»_space; significant effect on surrender value

Question 16

What is the profit on surrender using retrospective method?

Answer 16

EAS – SV = Profit to date

Question 17

What is the profit on surrender using prospective method?

Answer 17

(EAS – SV’) + (SV’-SV”)

= Profit to date + Capitalised profit from future differences between pricing and surrender basis

• EAS - earned asset share
• SV’ – prospective surrender value using pricing basis
• SV” – prospective surrender value using surrender value assumptions

Question 18

How do prospective surrender value assumptions affect profit retained?

Answer 18

• If SV assumptions represent exact future experience, profit retained is same as if ph hadn’t surrendered
• If SV assumptions are same as premium basis, only profit made to date is retained

Question 19

Choosing SV basis for prospective method to determine retained profit:

Answer 19

• Will lie between best estimate of future experience and premium basis
• Can be blended: premium basis at early durations and best estimate near maturity.
• Must check that SV < EAS to aboid lapse and re-entry

Question 20

How is a basis determined for retrospective method:

Answer 20

• Look at past experience
• Look at investment earnings, expenses, mortality and tax
• For regular premium contracts, won’t follow past experience exactly esp with investment returns to smooth the value

Question 21

Which assumptions are needed for prospective method:

Answer 21

• Interest
• Expenses
• Inflation
• Mortality
• Tax

Question 22

How is interest assumption determined for prospective method?

Answer 22

• For w/o profits, may cover L with fixed interest securities of a reasonable matching term»_space;
• Can consider:
  o Currented weighted average redemption yield of suitable securities as best estimate
  o Interest rate in premium basis if using a blended basis

Question 23

How is expense assumption determined for prospective method?

Answer 23

• Use expense investigation to get renewal expense levels
• Not likely to add margins as will increase surrender value
• Must make allowance for:
  o Renewal commission as paid
  o Surrender expenses

Question 24

How is inflation assumption determined for prospective method?

Answer 24

• Consistent with investment return assumption
• Real return anticipated on index-linked gov securities indicate what is suitable

Question 25

How is mortality assumption determined for prospective method?

Answer 25

* Must reflect future expected mortality for ph surrendering * Reasonable assumptions: surrenders have lighter mortality * Can: o Make explicit allowance for extra-light mortality o Use up-to-date experience and use other margins for different mortality experience if phs had not surrendered o Can use select mortality, but nature of selective process is not same as that in std table

Question 26

What is the surrender value for unit-linked contract?

Answer 26

Bid value – surrender penalty

Question 27

When would unit-linked policy have no surrender penalty?

Answer 27

High initial charges on policy

Question 28

When would unit-linked have monetary surrender penalty?

Answer 28

If there are reduced level allocation rates for several years.