Ch 26: Alterations Flashcards
There are 2 broad categories of alterations which can be made on conventional without profits contracts (excluding surrendering).
One of these is the ‘paid up’ (PUP) alteration.
Discuss this alteration in general terms (5)
Paid-up
Instead of paying SV on existing regular premium policy, PH receives PUP value/PUPsum assured.
- PH can stop paying regular prems, and still receive some eventual benefit
- T&Cs of original contract unchanged, except SA is reduced reflecting no more future regular prems
- effectively, policy value at PUP date used as single prem for new pol (excluding another round of init expenses)
- basis used for PUP value might differ from SV for 2 reasons
- costs of making pol PUP <> costs of paying SV
- may be less mortality selection effect, because PH keeps pol in force
- mortality selection likely more intense for SV=> expect SV basis to use lighter mortality than PUP value basis
There are 2 broad categories of alterations which can be made on conventional without profits contracts.
One of these is the ‘general alterations’, excluding paid ups.
Discuss this group of alterations in general terms:
Why might such general alterations arise? (2)
Give examples of general alterations (4)
What should alteration terms be consistent with? (3)
Describe the boundary conditions for alterations (4)
General alterations
Arise because life insurance contracts are long term
- Over time a mismatch between cover provided and current risks faced by PH
- to remove mismatch, PH may wish to buy additional contracts/alter current
4 examples of general alterations include
- change term of assurance (may include changing whole life to endowment)
- change type of contract eg from whole life to endowment
- change sum assured
- change premium payable
It is important to note
* insurer will quote T&Cs for proposed alteration, but ultimately PH decides
* hence important that terms offered for a given alteration are consistent
* with terms offered on other alterations eg SVs and
* current terms offered for new policies
Special alterations
* we refer to these as being boundary conditions
* eg reduce policy term to zero, equivalent to surrender
* reduce sum assured so no future prems required, equivalent to PUP
* increase SA, similar to keep original pol + buy increment pol at curr prem rates
Describe the PUP SA’s consistency with other benefits (4)
- PUP SA:
- supported by AS @ conversion date on best est date
- consistent with maturity values @ later durations, allowing for no prems
- consistent with SV => SV b4 and after conversion should be similar
- Exp profit PUP consistent with non-PUP
General policy alterations
Give 7 principles that should guide the calculation of terms to offer
Afforability of offered benefits from insurer’s view
-
terms after alteration supportable by earned asset share @ alt date;
- future prems after alteration plus current asset share
- should be sufficient to meet benefits + expenses on altered policy
-
profit expected
- from contract after alteration should be same as that before,
- or alternatively same as expected amount had policy been written originally on its altered terms
- costs associated with carrying out alteration should be recovered
Consistency with boundary conditions
* Surrendering policy = limiting case of reducing policy term
* as oustanding term changed to zero, prem charged consistent with difference btwn surrender and maturity value
* Conversion to PUP = limiting case of reducing premium
* prem after alteration approach zero as sum assured approach PUP value
* increased benefits=> terms consistent with additional prem for new pol with SA equal to proposed increase
* if term increased => terms should reflect current prem basis
* eg increased term for conventional endowment probably reduces premium, as same benefit payable later
* Ease of calc and explanation to PH
* Avoid Lapse and re-entry
* increases in premiums or benefits or term should reflect terms available for new business, in particular to minimise risk of lapse and re-entry
* issues: increased expenses, selection agains insurer
* Fairness
* any increase in benefit may be subject to additional evidence of health, to avoid potential anti-selection, depending in part on scale of alteration and when it occurs in policy’s lifetime
-
Stability
- small changes in benefits should result in small changes in premium
The principles set out in chapter 25 relating to this section also apply here
ACE AFS
What 2 broad methods do we have to calculate alteration terms?
- proportionate paid up values
- approximate method
- can be used to simplify calculation of PUP values
- equating of policy values
- most accurate method
Describe the ‘Proportionate PUP values’ used for policy alterations
How does the method generally work? (4)
Advantages (1)
Disadvantages (5)
Method
- For without profit endowments
- PUP SA = SA * (tot prem paid/tot prem payable)
- Gives approx value.
Meeting principles
Advantages
* Simple to apply and explain to PHs
Disadvantages
* PUP SA too high at short durations: don’t allow for high initial expenses.
* PUP SA too low at medium durations: don’t allow for investment returns
* Not consistent with surrender values
* method will give PUP values from very beginning
* surr value usually only available some time into policy, when asset share positive (which contradicts offering PUP value from beginning)
* usually expect PUP value to only be offered after surr value, as PUP policy still has renewal expenses (unlike surrendered contract) which need to be supported and would reduce earned asset share
- Early prems buy larger prop of SA than later ones
- due to compound interest on longer term
- prop PUP SA understate true value of policy
- tend to maturity value in LT
Describe the Equating policy values method used for policy alterations
How does the method generally work? (3)
- Method
- Value of contract before alteration on a prospective or retrospective basis,
- is equal to a prospective value after alteration
- The method can essentially be used for any type of alteration, including conversion to paid up status
- The alteration terms can be made appropriate in almost all circumstances, provided appropriate bases are chosen
Consider the example of a without-profits whole life assurance, with benefits payable imediately on death, where:
- x = policyholder age at date of issue
- e = level annual expenses (incurred m times a year)
- f = normal claims expenses
- (PUSA)t is the paid-up sum assured at policy duration t
- (SV)t is the surrender value at policy duration t
State the equation of value that can be used to determine the paid-up sum assured at policy duration t
- (PUSA)t*Abar1(x+t) + f*Abar1(x+t) + e*a(m)(x+t) = (SV)t
*annuity factor should have double dots for ‘in advance’
- Strictly, e should be renewal expenses associated with paid-up policies, but in practice this distinction is rarely drawn - although we must make sure that we do not charge paid-up policies for future renewal commission, which will make a big difference
- PUP Sums assured for endowment can be determined in a similar way
Consider the example of a without-profits whole life assurance, with benefits payable imediately on death, where
- x = policyholder age at date of issue
- e = level annual expenses (incurred m times a year)
- f = normal claims expenses
- tV = policy reserve at time t prior to alteration
- tV’ = policy reserve at time t after alteration
- P’ = future annual premium (paid m times a year)
- S’ = sum assured after alteration, payable immediately on death
- e’ = assumed future renewal expenses at date of alteration (incurred m times a year)
- C = cost of alteration
The policy is to remain a whole life assurance after alteration at time t, but for a different sum assured and premium. State and interpret an equation of value that can be used to determine S’ (for a given value of P’) or P’ (for a given value of S’)
- tV = tV’ + C
- => tV = S’*Abar1(x+t) + f’*Abar1(x+t) + e’a(m)(x+t) - P’*a(m)(x+t) + C
*we have essentually subsitituted the reserve calc/policy value for tV’
*annuity factor should have double dots for ‘in advance’
-
tV
- is calculated for the policy at alteration date, according to its original sum assured, premium, and policy conditions
- This equation says that
- {old policy value} + {value of new premiums} =
- {value of new benefits} + {value of new expenses} + {alteration expenses}, or
- [EPV of income} = {EPV of outgo}
When encountering an ‘equating policy values’ questions in an exam setting, what are some key steps which may help solve the question? (6)
- Start with equating values using an equation of the form:
- old policy value = new policy value + alteration expenses
- Decide whether to use a prospective or a retrospectve reserve
- question should state method to use for pol value calculations
- if nothing is specified, use prospective values
- Renewal expense assumption
- unless otherwise stated, expenses expressed as a % of premium will relate to the premium that applies to the reserve calculation (new or old) concerned
- Use of ultimate vs select mortality
- unless otherwise stated, any policy value calc’d at time t years through an existing policy will be calc’d assuming mortality appropriate to lives of select age [x] + t.
- so for all cases where AM92 mortality is assumed, reserves calculated for t>= 2 (greater than select period) will use ultimate mortality (irrespective of whether the lives were select or ultimate lives at age x)
Describe the Equating policy values method used for policy alterations
Outline the main advantages (5) and disadvantages (1) of equating policy values to calculate alteration terms. (Meeting the priciples)
Advantages
- Will produce consistent SV before and after alteration if the same methods and assumptions are used as for calculating SV
- For an extension of term or increase in benefit, use of the current premium basis to calculate the before and after alteration policy values would ensure consistency with NUB (unclear if other bases would)
- There will be consistency between the (boundary conditions) terms for alterations, surrender values and conversions to paid-up status, if the same bases are used
- Assuming the same basis is used for before and after policy values, the method is stable
- stable: minor alteration => minor premium change/whatever changed
- unstable: minor alteration=> major premium change/whatever changed
- Provided the policy value before alteration isn’t greater than the earned asset share, and the basis for the policy values after alteraion is not weaker than a best estimate basis, the alteration terms should be affordable.
Disadvantages
- Lapse and re-entry may be possible - the company would need to check the revised premium against that for a completely new contract
Give a brief overiew of what factors to consider when determining the basis used for setting alteration terms (4)
Consider:
- No assumptions are required for the proportionate paid up approach
- We need a set of assumptions for equating policy values, and should consider the following
- The expected profit from the alterered contract
- What kind of assumptions to use
- Impact of selection
Expected profit from altered contracts
What does the total profit from an altered contract depend on? (2)
What profit will be “released” at alteration date for the various bases used for the policy value before alteration? (3)
What profit will be expected to emerge from the alteration date, over the remaining life of the altered contract, for the various bases used for the policy value after alteration (2)
Total profits depends on the relationship between
* the method and basis for calculating the policy value before alteration, which determines profit “released” at time of alteration
* the method and basis for calculating policy value after alteration, which determines the profit expected to emerge over remaining contract term
The profit released at alteration date will be
* full expected profit under unaltered policy,
* if best estimate prospective value used for policy value before alteration
* no profit at all,
* if earned asset share is used for policy value before alteration
* something between,
* if prospective value using a basis incorporating margins is used for policy value before alteration
Expected profit emerge from alteration date over remaining life of altered policy will be
* no profit at all,
* if realistic prospective value used for policy value after alter
* profit corresponding to margins in assumptions,
* if prospective value using a basis incorporating margins is used for policy value after alteration
Impact on expected profit example
Sum assured for without profits endowment is being doubled and oustanding term reduced from 15 years to 10 years. Is equating policy values on realistic basis suitable method/basis of alteration? (5)
Increased sum assured and reduced oustanding terms
- using realistic basis for policy value
- before alteration takes full expected profit from original contract
- after alteration takes no future expected profit over remaining term
- hence overall expected profit unchanged
- given that policy has increased in size (sum assured doubled), it’s likely that an increase in profit would be required, so this method isn’t really ideal
Impact on expected profit example
For without-profits alterations, is there ever anything wrong with equating policy values using premium basis? (7)
Using premium basis for without profits alterations
- depends on which premium basis used!
- original premium basis
- highly unpredictable; conditions may have changed since pol incepted
- current premium basis
- often a good choice for without profits alterations
- pol val before alter: normally extract some profit (earned asset share)
- pol val after alter: produce some more profit (due to margins)
- if policy size increases (reduces) expected profit wil normally rise (fall), which will often seem reasonable
