Chapter 22 - Pricing Options And Guarantees

Question 1

What is a buy-back option?

Answer 1

To reinstate mortality cover after an accelerator (like CI) has paid out on specified event

Question 2

2 additional assumptions required when pricing an option

Answer 2

1. Probability that the option will be exercised
2. Expected mortality/morbidity of lives who choose to exercise the option

Question 3

Equation for the expected present value of the cost of an option:

Answer 3

E[PV of benefits] - E[PV of premiums]

Question 4

3 main methods to value health options:

Answer 4

1. North American method - requires extra data on likelihood of option being exercised and morbidity on those who do so
2. Conventional method - assumes all lives eligible to take up the option will do so and these lives will experience ultimate mobidity compared to the select morbidity they would have displayed had they been underwritten (copes less easily with multiple options)
3. Stochastic modelling - this uses stochastically generated proportions of lives in various risk groups, and their stochastically generated expected morbidity experience

Question 5

Some factors affecting health options are: (6)

Answer 5

1. Term of the policy with the option, longer the term longer PH will have option, more likely that health will deteriorate
2. Number of times PH get to exercise option
3. Conditions attaching to exercising the option
4. Encouragement given to PH to exercise option
5. Extra cost to PH who exercises the option
6. Selective withdrawals