Chapter 22 - options and guarantees

Question 1

The rough cost of a health option

Answer 1

= {proportion of lives exercising option) * {average extent that health of lives exercising option is worse than normal}

Question 2

Factors affecting health options

Answer 2

• 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 3

Extra assumptions when valuing a mortality/morbidity option

Answer 3

• the probability that the option will be exercised

- the expected mortality/morbidity of the lives who exercise the option

Question 4

North American method

Answer 4

Required two additional elements in the pricing basis:

• a double (triple) decrement table for lives who have not yet exercised the option with decrements of death/disability and exercising the option
• a mortality/morbidity table for the lives who have exercised the option

Question 5

Limitations of the North American method

Answer 5

Often difficult to obtain sufficient data to estimate all the decrement rates. For a new line of business, there will be no experience.

Question 6

Assumptions for conventional method

Answer 6

• all lives eligible to take up the option will do so
• the mortality/morbidity experience of the lives who take up the option will be the ultimate experience that corresponds to the select experience that would have been used as a basis if underwriting was completed as normal when the option was taken out
• the basis is not assumed to change over time

Question 7

Limitations of the conventional method

Answer 7

Not possible to use this method when:

• there are many possible dates on which an option may be exercised
• there is a choice from several alternative options

Assumed that the worst option is chosen with prob of 1

Question 8

Methods of costing options

Answer 8

• North American method
• conventional method
• stochastic modelling

Question 9

Stochastic modelling

Answer 9

• future experience is projected and the numbers taking up the various options and their subsequent claim propensities are investigated.
• A large number of simulations will be tested and the cost of the option will be calculated with a particular statistical degree of accuracy
• model will have to subdivide the population of policyholders into different subgroups (e.g. select and higher than ultimate)