Chapter 22 Pricing (4) Options and guarantees

Question 1

Mortality and morbidity options

Answer 1

• These are situations where the policyholder can choose to extend the term or increase the level of cover at normal premium rates but without providing further medical advice.
• Options have little impact on a one-year contract (PMI) , if the terms and acceptance are variable every year.

Question 2

Terms and conditions for options

Answer 2

• It is common for LTCI policies to include options:
• to purchase additional assurance without providing evidence of health at normal premium rates at date which option was exercised.
• to renew a LTCI policy eg a term CI insurance policy at the end of it original term without providing additional evidence of health.
• to reinstate mortality cover aafter an accelerated critical illness plan has paid out on a specified disease event.
• the terms and conditions under which options can be exercised should be clearly set out.
• eg every 5 years
• the extent of option shhould be clear
• eg additonal SI cannot exceed original SI.

-terms and conditions of option aim to reduce anti-selection.

Question 3

What are the cost of options?

Answer 3

• the value of excess of premium that should be charged in light of full underwriting information over the normal premium rate that is charged.
• for some lives the option will have no cost.
• the cost of an option depends on the health status of those that choose to exercise the option, and the proportion of lives that choose to exercise the option.

-cost of option = proportion of those exercising option * Average extent that health of lives is worse than normal.

Question 4

Factors affecting health options are?

Answer 4

• The term of the policy with the option
• The number of times the policyholder gets the chance to exercise the option.
• Conditions attaching to exercising the option
• Encouragement given to policyholders to exercise the option.
• The extra cost to policyholder who exercises the option
• selective withdrawals

Question 5

Options: Constant monitoring

Answer 5

• whatever the current experience, the value of options must be kept under constant review.
• it would not be unthinkable for a health insurance option to come into the money, much as deferred pension policies (despite being relatively worthless at the time of sale)

Question 6

Valuing a mortality/morbidity option requires two extra assumptions as part of the pricing basis:

Answer 6

• the probability of the option being exercised

- the expected mortality/morbidity of the lives who choose to exercise the option.

Question 7

What three methods can be used to value options?

Answer 7

• north american method
• conventional method
• statistical method

Question 8

The North american method requires two additional items:

Answer 8

• a double(or triple) decrement table for lives who have not yet exercised the option, with decrements of death/disability and exercising the option represented by dependent rates of decrement at age x of (aq)d,x and (aq)w,x respectively.
• displayed in double decrement table as (ad)d,x and (ad)w,x number of decrements out of (al)x lives.

Question 9

Limitations of the North american method

Answer 9

• it is often difficult to obtain sufficient data to estimate all the decrement rates
• for a new line of business there will be no direct experience
• conventional method is often preferred choice.

Question 10

The conventional method assumptions

Answer 10

• all the lives eligible to take up the option will do so
• the mortality/morbidity experience of those who take up the option will be ultimate experience that corresponds to the select experience that would have been used as a basis if underwriting had been completed as normal when the options was exercised.

-morbidity/mortality used is not usually assumed to change over time, so only the data required are select & ultimate tables used in original pricing basis.

Question 11

limitations of the conventional method

Answer 11

• it is not possible to use this method when there are many policy dates which an option may be exercised.
• the approximate approach taken here is that the worst option from the financial point of view is chosen with probability one.

Question 12

Stochastic modelling

Answer 12

• 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 adequacy.

Question 13

Guarantees: Resilience testing of premium rates

Answer 13

• this is sensitivity testing
• premium rates need to be assessed on a resilience basis to judge whether, in the absence of an ability to change the premiums/benefit relationship, the premium charged will be sufficient to meet all outgoings with an agreed level of confidence.
• this will require more establishment of reserves in earlier years.

Question 14

Guarantees: Adequacy of reserves in pricing

Answer 14

• actuary needs to incorporate into premium a loading to cover the additional cost of providing the guarantees including cost of holding the guarantee reserves.
• if the true cost of guarantees appears in the premiums, it may encourage many to move to a reviewable contract where the same benefits will cost less.

Question 15

Guarantees:Regulatory approval

Answer 15

-local regulator will normally want to see evidence of the techniques employed and their output, to judge the adequacy of the premiums and reserves required.