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 a surrender value on existing regular premium policies, the policyholder receives a paid-up value/paid-up sum assured.
- policyholder can stop paying regular premiums, and still receive some eventual benefit (becomes similar to single premium policy)
- T&Cs of original contract unchanged, except sum assured is reduced reflecting no more future regular premiums
- effectively, policy value at paid-up date used as single premium for new policy (excluding another round of initial expenses)
- basis used for paid-up value might differ from surrender value for 2 reasons
- costs of making policy paid-up <> costs of paying surrender value
- may be less mortality selection effect, because policyholder keeps policy in force
- mortality selection likely more intense for surrender value=> expect surrender value basis to use lighter mortality than paid-up 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 key factor regarding consistency relates to proposed alteration terms proposed by insurer? (3)
Describe the link which arises between alterations and common occurences (4)
General alterations
Arise because life insurance contracts are long term
- Policyholder maybe had sound idea of risks/needs when first purchased, but over time a mismatch arose between cover provided and current risks faced by policyholder
- to remove mismatch, policyholder 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 policyholder decides
- hence important that terms offered for a given alteration are consistent
- with terms offered on other alterations eg surrender values and
- current terms offered for new policies
There is a link between alterations and common occurances
- we refer to these as being boundary conditions for each other eg
- reduce policy term to zero, equivalent to surrender
- reduce sum assured so no future prems required, equivalent to calculating paid-up sum assured
- increase sum assured, similar to keep original policy + buy increment policy at current premium rates
Give 6 principles that should guide the calculation of terms to offer under general policy alterations
(1) Afforability of offered benefits from insurer’s view
-
terms after alteration supportable by earned asset share; future benefits + expenses on altered policy shouldn’t need more than
- future premiums after alteration plus
- current asset share
- profit expected from contract after alteration should be the 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
(2) Consistency with boundary conditions
- Terms of new policy should be consistent with paid-up sum assured, surrender values, and current premium rates (as relevant)
- as oustanding term changed to zero, premium charged consistent with difference between surrender and maturity value
- (surrendering policy = limiting case of reducing policy term)
-
premium after alteration approach zero as sum assured approach paid-up value
- (conversion to paid-up = limiting case of reducing premium)
- premium after increased benefit/term consistent with terms on new/current policy
- increased benefits=> terms consistent with additional premium for new policy with sum assured equal to proposed increase
- if term extended => terms should reflect current premium basis so far as extension is concerned
- eg increased term for conventional endowment probably reduces premium, as same benefit payable later; level of impact dependant on duration of extension and impact of expenses on
Other principles
(3) 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
(4) Lapse and re-entry
* increases in premiums or benefits or term should reflect terms available for new busines, in particular to minimise risk of lapse and re-entry (issues: increased expenses, selection against insurer)
(5) Stability
* small changes in benefits should result in small changes in premium
(6) Ease of calculation and explanation to the policyholder
What 2 broad methods do we have to calculate alteration terms?
- proportionate paid up values
- approximate method
- can be used to simplify calculation of paid-up values
- equating of policy values
- most accurate method
Describe the ‘Proportionate paid-up values’ used for policy alterations
How does the method generally work? (4)
Method
- For without profit endowments, paid-up value may be calculated as
- basic sum assured
- multiplied by ratio of
- total number of premiums actually paid to
- those originally payable throughout the total term
How does the proportionate paid-up method of calculating policy alterations perform in terms of meeting the principles which should be considered when setting alteration terms (as discussion earlier in the chapter)?
Advantages (1)
Disadvantages (4)
Meeting principles
Advantages
- Simple to apply and explain to policyholders
Disadvantages
- values too high at short durations: don’t allow for high initial expenses.
- values too low at medium durations: don’t allow for investment earnings.
- not consistent with surrender values
- method will give paid-up values from very beginning
- surrender value usually only available some time into policy, say 2 years when asset share positive (which contradicts offering paid-up value from beginning)
- usually expect paid-up value to only be offered after surrender value, as paid-up policy still has renewal expenses (unlike surrendered contract) which need to be supported and would reduce earned asset share
What is the overriding method used when calculating terms for policy alterations using equating of policy values?
(3)
- Value of contract before alteration
- on a prospective or retrospective basis,
- …can be equated to a prospective value after alteration
- that takes into account
- the requested changes to the terms of the contract.
- that takes into account
- 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 immediately 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
- PV(Benefit outgo) + PV(Expense outgo) = PV(Premium income)
- (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
- Paid-up 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)
In terms of meeting the principles that should be followed when calculating alteration terms, outline the main advantages (5) and disadvantages (1) of equating policy values to calculate alteration terms.
Advantages
- Will produce consistent surrender values before and after alteration if the same methods and assumptions are used as for calculating surrender vals
- For an extension of tem or increase in benefit, use of the current premium basis to calculate the before and after alteration policy values would ensure consistency with the terms for new contracts (unclear if other bases would)
- There will be consistency betwen the 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 shold consider the following
- The expected profit from the alterered contract
- What kind of assumptions to use
- Impact of selection
What does the total profit from an altered contract depend on? (2)
Total profits on an altered 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
What profit will be “released” at alteration date for the various bases used for the policy value before alteration? (3)
The profit released at alteration date will be
(can be thought of as profit for a surrender)
- full expected profit under unaltered policy, if realistic/best estimate prospective val used for policy value before alteration
- no profit at all, if earned asset share is used for policy value before alter
- something between, if prospective value using a basis incorporating margins is used for policy value before alteration
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)
Expected profit emerge from alteration date over remaining life of altered policy will be
(can be thought of as profit for a new contract)
- 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
