CH 25 - 26 (Surrenders and Alterations) Flashcards
Types of Discontinuance
- Surrender
(policy ceases with pre-specified benefit payable at termination) - Lapse
(policy ceases, no benefit payable) - Paid Up
(policy continues, but reduction of benefit at benefit date)
(Withdrawals
= Surrenders + Lapses)
Without-Profits Surrender Value Factors
PACD FEEL SAD
- PRE
(including consistency between old and new) - mustn’t exceed Asset share on average for period
- Competition
- Duration
(Earlier –> Use premiums paid and illustrations
Later –> Projected maturity values) - avoiding Frequent changes
(practicality + equity) - Ease of calculation
- impact of Early lapses (may want to recoup losses from early lapses)
-Legislation limitations
(e.g. annuity - might not be able to offer surrender because of tax differences)
- avoid potential Selection
(incl. surrender + re-entry) - Auction value
- enabling clear Documentation
Retrospective vs Prospective Features
Retrospective:
- Represents earned asset share at date of surrender
- Most suitable at early durations (for WoP)
- Disconnected from future values + experience
- Basis = actual past
BUT can change assumptions to give better value if too low or to retain profit
Prospective:
- Represents what contract is worth to the company
- Enables company quantify how much profit to retain
- Basis: Assumptions on interest, expenses, inflation, mortality, tax
- Most suitable later
(for WoP)
- May be used to achieve results tested against retrospective
Unit-linked Surrender Values
-Typically bid value of units, less penalty
-Penalty:
> Percentage of unit value
> Percentage of premium
-Penalty typically higher at early durations
(to recoup shortfalls from initial expenses not yet recovered through initial charges)
Pros and Cons of Using Auction Value
Pros:
- Independent assessment
- More likely to be accepted as fair by the policyholder
Cons:
- Likely different assumptions to the insurer
- Value may fluctuate unpredictably
- Value may be difficult to determine without actually offering the policy up for sale
Two Methods of Asset Share Averaging
- Do once per year
- Smoothed asset share
(smooth over chosen period)
Advantages + Limitations of Retrospective vs Prospective
Retrospective Advantages:
1. Represents the max a company could pay without making a loss
2. At early durations may be reasonable compared with premiums paid
3. May be consistent with values quoted in product disclosure literature
4. Not overly complicated provided necessary info
Retrospective Limitations:
1. Doesn’t speak to profit sacrificed
(e.g. giving full asset share will mean no profit is retained)
2. Won’t run into maturity value (except by chance)
3. Can produce values significantly different from realistic (prospective) value, which is typically used as auction value
–> Reputation risk of poor surrender terms in markets
(depending on competitors and basis)
Prospective Advantages:
1. If realistic basis used with the method it will produce a surrender value that represents what the contract is worth to the company
2. Therefore, it enables the company to quantify how much profit to retain and hence maintain equity with continuing policyholders and any shareholders
3. Surrender values will run into the maturity value, for without-profits
4. Relatively easy to operate
Prospective Limitations:
1. Can produce surrender values that look unreasonable at early durations
2. No guarantee that surrender values will consistently exceed asset share
Retained Profit Formula
Profit retention relates to excess of earned asset share over SV paid. The higher SV paid compared to asset share, the less profit we retain.
= (Profit made to date)
+
(Capitalised value of profit to arise in future)
= (Asset share
- Prospective surrender value under office premium assumptions)
+
(Prospective surrender value under office premium assumptions
- Prospective surrender value under surrender basis assumptions)
…if SV basis is best estimate, will be as though policy wasn’t surrendered.
…if SV basis is premium basis, then profit retained will just be that to date
(ideally want somewhere in between the two - typically start at premium basis and run into best estimate)
Factors in Choice of Alteration Terms
ABS LEAFS
- Affordability (alteration needs to be supported by earned Asset share)
- consistency with Boundary conditions
(surrender/paid-up/new policy) - Stability
(small changes, small results) - avoiding Lapse and re-entry
- Ease of calculation and explanation to policyholder
- recovery of Alteration cost
- Fairness
- risk of financial/mortality Selection
(incl whether underwriting is applicable at time of alteration)
Methods of Alteration
- Equating policy values before and after alteration (with suitable profit extracted after alteration)
[L CASA
…can be used for all Alterations
…ensures Consistency with terms of contracts
…typically Stable
…should be Affordable
…may induce Lapse and re-entry still] - Proportionate method: Multiply sum assured by (premiums paid)/(total premiums)
[SPAC
… for Paid-up values
…Simple,
…but problematic Amount: too high at early durations and too low at later durations;
unlikely to be Consistent with surrender values] - Unit-linked contract method:
Attached units remain attached, possibly after deduction of a penalty
(to recover initial expenses)
…likely to only have contractually limited options in alterations
Types of Alterations
- Paid-up
- Change sum assured
- Change premiums
- Change term
- Change type of contract
Boundary Conditions
- Reducing term vs Surrendering
- Reducing sum assured vs Paid-up
- Increasing sum assured vs Purchasing additional increment
Principles behind paid-up values
- should be consistent with Surrender values
(slightly different because costs of PU different to SV + mortality of SV likely to have selection since p/holders don’t keep the product) - should be supported by earned Asset share at date of conversion on expected basis
- should be consistent with Maturity values later in duration
Formulas for Alterations
PAID UP
Paid-up prospective value
= surrender value
ALTERATIONS
Value before alteration
=
Value after alteration
+ Cost of alteration
(solve for new P and S jointly)
Profit Scenarios on Alteration
- If best estimate basis used for policy value before alteration, profit will be instantly realised
- If earned asset share used for value of before, profit will be zero
- Somewhere in between the two scenarios is typically used (inverse for after-basis)
