Chapter 25 Flashcards
1
Q
What is the most important reserve with regards to surrender values?
A
The supervisory reserve - in most countries ICs are required to hold a reserve at least equal to the SV to cover the possibility of a mass surrender over the ST future.
2
Q
Describe the pattern of reserves for a WOL, EA and TA.
A
Reserves for WOL and EA increase with increasing policy durations.
Reserves for TA decrease with increasing policy durations.
3
Q
What are the reasons for not offering SVs on term assurances?
A
- Low AS
- Cost of selective withdrawals
- Recoup losses on early lapses by making profits on later lapses
- AS quite volatile, difficult to devise SV scale that would treat PHs fairly
- AS can be negative at late durations or likely to be decreasing towards the end of the policy
4
Q
What are the factors to consider in determining without-profits surrender or alteration values?
A
- Competitors’ surrender/alteration terms should be considered
- Simple to:
- Values of surrender should not exceed the earned AS
- PRE may play a role
- Avoid anti-selection against the company, e.g.
- Stability, i.e. small changes in benefits should lead to small changes in premiums
- Ensure consistency with boundary conditions
- TCF should be considered
- Costs relating to alteration/surrender should be covered
- Requirements imposed by regulation or professional guidance should be considered
- SV terms in conjunction with current premium rates should not make it advantageous to PHs to discontinue the policy and take out a new policy
5
Q
Discuss the information under “Competitors’ surrender/alteration terms offered should be considered”
A
- It is reasonable for an IC to want to be seen to offer competitive SV and maturity terms
- It will be embarrassing for a company if any comment on SVs in literature conflicted with figures shown in the financial press surveys
6
Q
Discuss the information under “Simple to:”
A
- Explain to PHs
- Calculate and administer - likely to require smoothing of the real situation (cross-subsidy) and ensure that subsidy not detrimental to IC or PH
- The SV process should be documented clearly
7
Q
Discuss the information under “Values of surrender should not exceed the earned AS”
A
- The AS should represent the max that the company must hold in respect of a policy
- The AS for without-profit contracts does not include deduction for SH transfers
8
Q
Discuss the information under “PRE may play a role”
A
- Later durations: benefits close to maturity should look reasonable compared to the original maturity benefit, given the type of alteration and auction values
- Early durations - terms should look reasonable compared to premiums paid to date and illustrative values
9
Q
Discuss the information under “Avoid anti-selection against the company, e.g.”
A
- Alterations or surrenders should avoid lapse and re-entry
- Increase in benefits may require further underwriting
10
Q
Discuss the information under “Stability, i.e. small changes in benefits should lead to small changes in premiums”
A
- Alteration basis should also not change too often, unless financial conditions require a change
- Avoid discontinuities in terms - surrender scales should not contain discontinuities by duration to maintain equity between PHs who surrender on either side of the discontinuity
11
Q
Discuss the information under “Ensure consistency with boundary conditions”
A
- The premium after reducing the SA should be consistent with the paid-up values
- Increases in benefits should be consistent with taking out a new policy
- SV before the alteration should be similar to the SV after the alteration
12
Q
Discuss the information under “TCF should be considered”
A
- Future profits earned from the altered policy should be fair
- Terms offered should be fair to
– PHs that are altering/surrendering
– Those that are not
13
Q
By what is PRE influenced?
A
- Past practice of the company
- Literature issued by the company
- Market practice
- Legislation and regulation
14
Q
Describe PRE for discontinuance at short durations.
A
- Natural for PH to compare SV with premiums paid, or premiums paid + interest (AS usually less than this)
– Prospective policy value based on best estimates of future experience likely to be even smaller - IC may feel obliged to accept a loss or a reduced profit on surrender up to several years into contract so that SV does not appear too low compared to premiums paid – try to recoup cost from later surrenders
15
Q
Describe PRE for discontinuance close to maturity.
A
- PH will expect that SV close to maturity will be consistent with benefit upon maturity
- SV payable @ end of each policy year should progress smoothly into maturity value at end of contract – achieved by applying SV derived from prospective policy values
16
Q
What is the auction value of a policy?
A
The value a policy would fetch if the PH were to transfer it as an ongoing policy to someone else.
17
Q
What is the advantage of looking at the auction value when determining the surrender value?
A
The value has the advantage of being an independent assessment and more likely to result in the value which the PH would accept as fair.
18
Q
Why would the auction value generally be unsuitable from the IC’s POV?
A
- The underlying assumptions would usually be different from the company’s own assumptions.
- The value may fluctuate unpredictably and may be difficult to determine without actually offering the policy up for sale.
19
Q
What are the features of the retrospective method for calculating surrender values?
A
- It will represent the EAS at the date of surrender or an estimate thereof.
- It would represent the max that the company could pay without making a loss.
- If the company adopts a retrospective method to calculate some or all of its specimen SVs in product disclosure literature, PHs would expect it to do the same for actual values.
20
Q
What are the features of the prospective method for calculating surrender values?
A
- If a realistic basis is used it will produce a SV that represents what the contract is worth to the company.
- It calculates how much it will cost the IC to provide benefits and associated expenses allowing for future expenses.
21
Q
What are the advantages of using the retrospective method to calculate SVs?
A
- It is reasonable if initial expenses are reasonable.
- It is suitable for short duration.
- Not overly complex if information needed to build up the EAS is available.
22
Q
What are the advantages of using the prospective method to calculate SVs?
A
- If you use a realistic basis, it enables the company to quantify how much profit to retain - hence maintain equity with continuing PHs and any SHs.
- SVs will run into the maturity value.
- Suitable for medium or longer durations.
- More likely than the retrospective method to produce SVs comparable to those available at auctions and competitors. Prospective method usually used for comparisons with competitors.
- Relatively easy to operate unless the company decides to use a complicated basis - do not require any information of what happened in the past.
23
Q
What are the disadvantages of using the retrospective method to calculate SVs?
A
- Retains no profit.
- Does not say anything about the profit the company would have made if the contract were not surrendered - not easy to ensure equity with either continuing PHs or with any SHs.
- Could be inconsistent with maturity value.
- Could produce values that are significantly different from realistic prospective value.
24
Q
What are the disadvantages of using the prospective method to calculate SVs?
A
- The main difficulty is deciding on the rate of interest - difficult to apply to short durations.
- There is no guarantee that SVs produced will not consistently exceed the EAS.
- Depending on the basis used, method could produce SVs at early durations that look distinctly unreasonable from surrendering PHs’ POV.
25
Why are auction values likely to be calculated using a prospective value?
* Values are set by external organisations and people without access to the confidential information necessary to calculate an AS.
* A prospective buyer will be interested in the future return on the policy, rather than what someone else has paid into the policy in the past.
26
What method is normally used to calculate the SV in early years?
The retrospective approach - need to pay particular attention to the actual expenses incurred.
27
Why is the retrospective not used throughout the contract term to set the SVs?
It becomes increasingly difficult to find the right combination of factors to produce values which run into the maturity value.
28
What method is used to calculate the SV in later years?
The prospective method - it is more convenient since it is only necessary to value the future benefits, premiums and expenses.
29
What is the main difficulty of using the prospective method to calculate SVs?
Deciding on an appropriate interest rate - small changes in the IR will have significant impact on the SV.
30
Why does the retrospective method not retain any profit?
The SV calculated under the retrospective method is approximately equal to the earned AS. They will probably not want to use this approach for long.
31
When using the prospective method to calculate SVs, on what will the amount of profit retained depend?
On the relationship between the assumptions used to calculate the SVs and those used in the office premiums.
32
What is the formula for the profit retained under the prospective method for calculating SVs?
(EAS - SV') + (SV' - SV")
where:
* EAS = earned asset share
* SV' = prospective surrender value using same assumptions as used to calculate the office premium
* SV" = prospective surrender value using SV basis assumptions
* (EAS - SV') = profit that has been made to date
* (SV' - SV") = capitalised value of profit that will arise in future from differences between the premium rate assumptions and the prospective SV assumptions
33
How will the retained profit vary for different values of the SV basis assumptions?
* If SV assumptions exactly represent future experience, the total profit retained will be the same as if the contract had not been surrendered.
* If SV assumptions are the same as those used in the office premium basis, then the company only retains the profit it has made to date.
34
How can the company adjust how much profit it retains in accordance with its corporate aims?
By a suitable choice of basis - between best estimate of future experience and premium basis assumptions.
35
How does a blended assumption basis work with regards to calculating the SVs under the prospective method?
* Start with the premium basis assumptions near the entry
* The basis runs into the best estimate assumptions nearer to maturity
36
How soon should the premium basis assumptions run into the best estimate assumptions?
It will depend on how quickly the company feels it can start retaining the same profit as from a non-surrendered contract.
37
How is the basis for the retrospective method determined?
In early years, the company will need to examine the actual past experience for all the relevant factors which will include investment earnings, expenses, mortality and possibly tax.
38
Why would an IC use a basis under the retrospective method different from the actual experience?
* Retain some profit - use an investment return lower than actual to create a retrospective value lower than the "true" AS
* Increase low SVs - deduct a lower than true value for expenses from the AS if the true AS gives an embarrassingly poor SV
* Competitive reasons
39
What assumptions will be needed to determine the basis for the prospective approach?
* Interest - most important
* Expenses
* Expense inflation
* Mortality
* Possibly tax
40
How would you determine the interest rate assumption under the prospective method for determining SVs?
* Use the current weighted average redemption yield of suitable matching securities as the best estimate assumption.
* Consider the interest rate used in the premium basis if it wishes to use a blended basis.
41
How would you determine the expense assumption under the prospective method for determining SVs?
* The most recent expense investigation will indicate the level of renewal expenses.
* Allowance needs to be made for expenses involved in surrendering the policy.
* Allowance needs to be made for any renewal commission.
42
How would you determine the expense inflation assumption under the prospective method for determining SVs?
* The inflation rate should be chosen to be consistent with the investment return assumption.
* The real return anticipated on index-linked government stock will give an indication of what might be a suitable margin below the full interest rate assumption.
43
How would you determine the mortality assumption under the prospective method for determining SVs?
* The mortality basis chosen should reflect the future expected mortality for those PHs who are surrendering.
You could either:
* Make some explicit allowance for extra-light mortality
* Or you could use up-to-date experience and rely on other margins in the basis for any difference which might have emerged had those policies not been surrendered.
* Or select mortality could be used.
44
How is the SV under a UL contract determined?
* Bid value of the units held in the fund
* Less the SP (usually large at early durations and decreasing over time). Stipulated as either:
--- % of premium
--- % of unit fund value
--- Consider charging structure when setting SP: how much of expenses (especially initial expenses) have been recouped
