Ch27: Cost of guarantees and options

Question 1

Methods to determine value of options/guarantees

Answer 1

• option-pricing techniques: these assess the extra premium by looking at the market price of a derivative that the insurance company could acquire to mitigate the risk
• stochastic simulation of investment performance: the extra sums likely to be needed under the guarantee can be modelled by simulating a range of investment scenarios

Question 2

Cost of mortality option

Answer 2

Value of the excess of the premium that should, in light of full underwriting information, have been charged for the additional assurance over the normal premium rate that is charged

cost = {proportion of lives exercising option} * {average health of lives exercising option}

Question 3

Factors affecting mortality options

Answer 3

• the term of the policy with the option
• the number of times the policyholder gets to exercise the option
• conditions attaching to exercising the option
• the encouragement given to policyholders to exercise the option
• the extra cost to the policyholder who exercises the option
• selective withdrawals

Question 4

Valuing mortality option

Answer 4

• usually valued using cashflow projections
• projections would include additional benefits expected to be payable under the option and the additional premiums expected to be received, to the extent to which the option is expected to be taken up
• additional premiums would be based on the expected premium rates that would be charged to standard lives for the additional benefits, as at the option exercise date
• projection should allow for any additional expenses incurred in administration of the option
• if pricing the option, allowance should be made for additional reserves that should be held

Question 5

Extra assumptions for valuing a mortality option

Answer 5

• the probability that the option will be exercised at each possible exercise date
• the additional benefit level that will be chosen
• the expected mortality of the lives who choose to exercise the option
• the expected mortality of the lives who choose not to exercise the option
• additional expenses relating to the option