Ch 25: Surrender values Flashcards
What do we mean by ‘surrender’? (1)
What kind of reserves is it important for us to consider to assist in setting surrender values? What do we compare these to? (2)
Surrender relates to policyholders terminating contracts early in return for an immediate cash payment
- Insurer no longer needs to hold a reserve for the contract, hence surrender value can be paid
It is normally useful to consider prospective and retrospective reserves when calculating surrender values.
- We compare these reserves to the asset share at time of surrender
What type of contracts do we mainly consider surrender values for in this course?
We mainly consider surrender values for conventional without profits contracts
For each of these, why may (or may we not) offer SVs?
Endowment/whole of life (2)
Endowment/whole of life
- reserves increase with policy duration, hence SV can be paid
- SV (and reserves) typically increases towards sum assured
For each of these, why may (or may we not) offer SVs?
Term assurance (5)
Term assurance: usually no surrender value because
- reserves always very small compared to sum assured
- cost of selective withdrawals => reduced if no SV
- recoup losses on early lapses (when ass share negative) by making some profit on later lapese (when ass share positive)
- asset shares quite volatile, so difficult to devise SV which treats PHs fairly in relation to this
- ass shares can be negative and/or decreasing at later durations/towards end of policy=> hard to sell this to PHs
For each of these, why may (or may we not) offer SVs?
Immediate annuity (2)
Immediate annuity: usually no surrender values because
- PHs would want to surrender only if think they’ll die soon
- hence, giving SV would => improved longevity of remaining lives=> big cost
- also, legislation may not allow this, if tax privileges were granted for certain contract types providing long term annuity income in retirement to relieve burden on state
- if SVs given, people would use these contracts as savings vehicle to benefit from tax concessions = defeating goverment aims
List principles that should be considered when calculatings surrender values
(8)
Siobhan’s secret acronym hehe
- S- Avoid Selection against insurer
- A- Not exceed Asset shares, in aggregate, over reasonable time period
- C- Competitors’ surrender values (and possibly also auction values, where applicable)
- E- Ease of calculation; Not excessively complicated to calculate, accounting for computing power available
- C - Be capable of being documented clearly
- D - Durations
– At early durations, not appear too low compared with premiums paid, accounting for any projected maturity values
– At later durations, be consistent with projected maturity values
– Not be subject to significant discontinuities by duration - F- Not be subject to Frequent change, unless dictated by financial conditions
- P- PRE
– Treat both surrending and continuing policyholders equitably
Discuss the influence of PRE when setting SVs in terms of
Discontinuance at short durations (4)
Discontinuance at short duration
- SVs likely compared to premiums paid (sometimes with interest), but usually ass share less than this
- prospective policy value based on best estimates of future experience likely to be even smaller
- insurers may feel obliged to accept losses/reduced profit on SVs several years into contract
- could penalise later surrenders to cope/not offer SVs at all for some initial time
Discuss the influence of PRE when setting surrender values in terms of
Discontinuance close to maturity (3)
Discontinuance close to maturity
- where maturity benefit payable, policyholders will expect the surrender value prior to maturity to be consistent with this
- Surrender values should progress smoothly at each year end into maturity value
- achievable for without profits contracts: base surrender value on prospective policy values
Define auction values
Advantages and Disadvantages of auction values
- auction value is what policy obtained if PH transferred ongoing policy to someone else, dealt with by specialist brokers)
- If the policyholder is dissatisfied with the surrender value, they can attempt to obtain a higher value in the second-hand market
Advantages - auction values assessed independently = hence PHs may accept as fair
Disadvantages- the underlying assumptions for auction values would probably be different from the company’s assumptions eg optimism of future benefits of policy
- values fluctuates unpredictably => hard to determine, without actually selling policy
Discuss the influence of PRE when setting SVs in terms of
What was disclosed at new business (2)
New business disclosures
- new business sales sometimes accompanied by prospective SV illustrative values by duration (may be regulatory requirement)
- potentially embarrasing if SVs given/quoted in financial press surveys differ significantly from new business literature
Discuss the influence of Earned Asset Share when setting SVs according to following:
What does the asset share represent in general? (1)
What implication does this have for SVs? (2)
What does using asset share for SV calcs mean in terms of profit/loss distributions (1)
How might we achieve averaging over time when using asset share for SVs? (3)
Asset Share represents
- money insurer has really accumulated in respect of policy, unlike supervisory reserve (represents how much money company must hold)
Earned asset share can be used interchangably with asset share
- SVs must not exceed earned asset share in aggregate over a reasonable time period
The implication is
- asset share theoretically guides the maximum the insurer can afford to pay out, measured over a reasonable time period
- but it is not unique value which can be afforded in all cases i.e could give some policies more, some less
Basing SVs closely on asset shares implies
- distributing accrued profits/losses to policyholders, because asset share containing all of accumulated profits/losses from policies to date
Averaging over time for SVs can be achieved in 2 ways:
- by period of asset share calc eg. 1 per year (practical) => averaging over year
- smoothed asset share as basis for SV
- Decide time period(s) to smooth over, e.g. want to smooth individuals months’ asset share values so total impact of smoothing over 12 months is zero or smooth individual years’ asset share values so that the impact over perhaps five years is zero.
Consider the example of a without-profits whole life assurance for a sum assured of S, payable immediatley on death, with annual office premiums of G payable m times a year, where:
- x = policyholder age at date of issue
- I = initial expenses in excess of those occuring regulalry each year
- e = level annual expenses (incurred m times a year)
- f = normal claims expenses
- C = surrender expenses
State formulae for the retrospective reserve and the prospective reserve for the policy at policy duration t, and explain how these can be used to determine a surrender value.
Retrospective method
- Provided sufficient info + computing facilities, insurer may keep up-to-date asset share per contract to use to calc a SV
- however, rarely true for without profits contracts, so use retrospective reserve to deduce SV
- use formula/parameters chosen to produce acceptable results at duration required; starting point for basis is experience of policy.
-
Retrospective reserve
- D(x) / D(x+t) * { G*a(m)(x:t) - S*Abar1(x:t) - f*Abar1(x:t) - e*a(m)(x:t) - I } - C
- *annuity factor should have double dots for ‘in advance’
Prospective method
- For without profits contracts, this is value of future benefits/expenses, net of future premiums due, using estimates of future expected assumptions
-
Prospective reserve
- S*Abar1(x+t:) + f*Abar1(x+t) + e*a(m)(x+t) - G*a(m)(x+t) - C
- *annuity factor should have double dots for ‘in advance’
Table of surrender values by policy duration usually a blend of these 2 values, subject to minimum value of 0 (blending towards the prospective reserves at later durations).
State the main advantages and disadvantages of using the retrospective method for calculating surrender values
Advantages (4)
Disadvantages (3)
Other points to consider (1)
Advantages
- Represents the Earned Asset Share => maximum company could pay without making a loss
- At early durations, may be reasonable compared with the premiums paid
- If the company adopts this method to calculate its specimen surrender values, it may be consistent with values quoted in product disclosure literature
- Not overly complicated, provided necessary information available to build up earned asset share/determine suitable parameters if formula is used
Disadvantages
- For without-profit contracts
- gives no indication of profit which would’ve been earned without surrender, hence, not easy to ensure equity either with continuing policyholders or with any shareholders
- will not necessarily approach the maturity value, except by chance
- future benefits/expected experience ignored. So values may be significanlty different from a realistic prospective value, which is likely to be the approach used to calculate auction value.
- The most complex component of the method is obtaining the necessary historic information and computing resources availability
Other points
- Consistency with competitors depends on the method and basis used
State the main advantages and disadvantages of using the prospective method for calculating surrender values (7)
Advantages (4)
Disadvantages (3)
Advantages
- If realistic basis used with the method it will produce a surrender value that represents what the contract is worth to the company
- Therefore, it enables the company to quantify how much profit to retain and hence maintain equity with continuing policyholders and any shareholders
- Ther surrender values will run into the maturity value, for without-profits
- It’s relatively easy to operate
Disadvantages
- There is no guarantee that the surrender values produced will not consistently exceed the asset share
- It could produce unreasonably low surrender values at early durations, from the policyholder’s point of view
- Likely to produce comparable surrender values to those available at auction and for comparable competitors’ contracts - although the basis used will be more influential in the comparison than the method.
List the steps that go into, and need to be broadly considered, to calculate SVs
(4)
- Choose method
- Consider profit retention implied by method used
- Determining the basis for either
- retrospective value
- prospective value