25. Surrender values Flashcards
Why are surrender values not paid for term assurances?
- Low asset shares
- High risk of selective withdrawals
- Recoup losses on early lapses when asset share is negative by making some profit on later lapses when asset share is usually positive.
- Asset shares are volatile, so would be difficult to create a surrender value scale that would treat policyholders fairly
- 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
Why are surrender values not paid for immediate annuities?
- Selective withdrawals leaving average mortality of remaining ph to improve
- 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
What are the principles for calculating surrender values?
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
What is the auction value?
Value a policy would fetch if the ph were to transfer it as an ongoing policy to someone else
Advantage of using auction value to compare surrender value
Independent assessment and likely to be seen as fair by ph
Why might auction value not be suitable for company?
- 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
Two methods of calculating surrender value
- Retrospective method
- Prospecrive method
Retrospective method
- Represents earned asset share or an estimate thereof
- Maximum company can pay without making a loss
Advantages of retrospective method
Disadvantages of retrospective method
- 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
Retrospective method and meeting the principles
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
Prospective method
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.
Prospective method and meeting the principles
- 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
What is the challenge with using the retrospective value throughout the term of a policy?
- If using formula, might be hard to find right combination of parameters to produce SV that run into maturity value
What is the challenge with using the prospective value throughout the term of a policy?
- 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
What is the profit on surrender using retrospective method?
EAS – SV = Profit to date
What is the profit on surrender using prospective method?
(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
How do prospective surrender value assumptions affect profit retained?
- 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
Choosing SV basis for prospective method to determine retained profit:
- 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
How is a basis determined for retrospective method:
- 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
Which assumptions are needed for prospective method:
- Interest
- Expenses
- Inflation
- Mortality
- Tax
How is interest assumption determined for prospective method?
- 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
How is expense assumption determined for prospective method?
- 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
How is inflation assumption determined for prospective method?
- Consistent with investment return assumption
- Real return anticipated on index-linked gov securities indicate what is suitable
How is mortality assumption determined for prospective method?
- 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
What is the surrender value for unit-linked contract?
Bid value – surrender penalty
When would unit-linked policy have no surrender penalty?
High initial charges on policy
When would unit-linked have monetary surrender penalty?
If there are reduced level allocation rates for several years.
