Chapter 25-Surrender Values Flashcards
List principles that should be considered when calculating surrender values
(11)
(1) PRE
(2) Treat both surrendering and continuing policyholders equitably
(3) At early duration, not appear too low compared with premiums paid, accounting for any projected maturity values
(4) At later duration, be consistent with projected maturity values
(5) Not exceed asset shares, in aggregate, over reasonable time period
(6) Competitors’ surrender values (and possibly also auction values, where applicable)
(7) Not be subject to frequent change, unless dictated by financial conditions
(8) Not be subject to significant discontinuities by duration
(9) Not excessively complicated to calculate, accounting for computing power available
(10) Be capable of being documented clearly
(11) Avoid selection against insurer
Discuss the influence of PRE when setting SVs in terms of
Discontinuance at short durations (4)
SVs likely compared to premiums paid (sometimes with interest), but usually asset share less than this
prospective policy value based on best estimates of future experience likely to be even smaller
insurers may feel obliged to accept losses/reduced profit on SVs several years into contract
Discuss the influence of PRE when setting SVs in terms of
Discontinuance close to maturity (3)
where maturity benefit payable, PHs will expect SV prior to maturity to be consistent with this
SVs should progress smoothly at each year end into maturity value
achievable for without profits contracts: base SV on prospective policy values
Discuss the influence of PRE when setting SVs in terms of
How they compare to auction values (4)
auction value is what policy obtained if PH transferred ongoing policy to someone else
auction values assessed independently hence PHs may accept as fair
often unsuitable, though
+difference in assumptions used
+values fluctuate unpredictably
Discuss the influence of PRE when setting SVs in terms of
What was disclosed at new business (2)
new business sales sometimes accompanied by prospective SV illustrative values by duration (may be regulatory requirement)
potentially embarrassing if SVs given/quoted in financial press surveys differ significantly from new business literature
Discuss the influence of Earned Asset Share when setting SVs according to following:
What does the asset share represent in general? (1)
What does using asset share for SV calcs mean in terms of profit/loss distributions (1)
How might we achieve averaging over time when using asset share for SVs? (3)
Asset represents money insurer has really accumulated in respect of policy, unlike supervisory reserve (represents how much money company must hold)
SVs must not exceed earned asset share in aggregate over a reasonable time period
The implication is
Basing SVs closely on asset shares implies distributing accrued profits/losses to PHs
Averaging over time for SVs can be achieved in 2 ways:
+Calculated once per year (implicit average)
+smoothed over a period which has to be decided
State the main advantages and disadvantages of using the retrospective method for calculating surrender values
Advantages (4)
Disadvantages (3)
Other points to consider (1)
Advantages
Advantages:
+Represents maximum company could pay without making a loss
+At early durations, may be reasonable compared with the premiums paid
+It may be consistent with values quoted in product disclosure literature
+Not overly complicated, provided necessary information available to build up earned asset share/determine suitable parameters if formula is used
Disadvantages
+For without-profit contracts
gives no indication of profit which would’ve been earned without surrender, hence, not easy to ensure equity either with continuing policyholders or with any shareholders
+will not necessarily run into the maturity value, except by chance
+future benefits/expected experience ignored. So values may be significantly different from a realistic prospective value, which is likely to be the approach used to calculate auction value.
+The most complex component of the method is obtaining the necessary historic information and computing resources availability
Other points
Consistency with competitors depends on the method and basis used
State the main advantages and disadvantages of using the prospective method for calculating surrender values (7)
Advantages (4)
Disadvantages (3)
Advantages
+If realistic basis used with the method it will produce a surrender value that represents what the contract is worth to the company
+Therefore, it enables the company to quantify how much profit to retain and hence maintain equity with continuing policyholders and any shareholders
+The surrender values will run into the maturity value, for without-profits
It’s relatively easy to operate
Disadvantages
+There is no guarantee that the surrender values produced will not consistently exceed the asset share
+It could produce unreasonably low surrender values at early durations, from the policyholder’s point of view
+Likely to produce comparable surrender values to those available at auction and for comparable competitors’ contracts - although the basis used will be more influential in the comparison than the method.
Calculate SV: Choice of method
How might we use retrospective and prospective methods for the eventual SV calculations? (1)
In early years/policy durations what do we have to pay particular attention to when calc’ing SVs? (3)
Discuss the use of retrospective method throughout policy duration for SVs (1)
In later years/policy durations what might we do for SV calcs? (4)
For eventual SVs
produce a table of SVs by policy duration which is a blend of retrospective and prospective values, subject to min value of zero
In early years,
pay close attention to actual expenses incurred (particularly initial expnses)
other factors are of lesser importance in short term
retrospective values are likely to be more natural approach
Theoretically, could just use retrospective throughout policy duration for SVs
but can become increasingly difficult to find right combo of factors to produce values which run into maturity if calc had to be done by devising some independent formula and setting parameter values for it
After earlier years
prospective methods more convenient, since only necessary to value future benefits, premiums and expenses
main difficulty is deciding appropriate interest rate
thus difficult to apply at short durations and, hence, long outstanding
…because small changes in interest rate => big effect on SV
What do we mean by ‘profit retention’ in context of SVs? (2)
What other important feature must be checked when deciding on method for SV calcs? (2)
Profit retention relates to
excess of earned asset share over SV paid,
the higher SV paid compared to asset share, the less profit we retain
Also important to check for lapse and re-entry risk due to chosen basis
Comment on use of retrospective method for SVs in relation to retained profit (1)
Retrospective method profit retention => no profit
wouldn’t want to use retrospective method for too long, since SV is equal as asset share
For prospective method SV calc, show how insurer profit retained on surrender can be split into (a) past profit and (b) capitalised value of future profit by considering SV calculated on the premium basis (5)
Prospective method profit retention
depends on relationship between SV assumptions vs office prem assumptions
if profit allowance contained solely in assumption margins used to calc office premium then profit retained can be specified as
(EAS - SV’) + (SV’ - SV”),
where
EAS = earned asset share
SV’ = prospective SV using office premium assumptions
SV’’ = prospective SV using surrender value basis assumptions.
1st part, (EAS - SV’), represents the profit that’s been made to date
2nd part, (SV’ - SV’’), represents capitalised value of profit that will arise in future.
How can the SV assumptions used impact insurer’s retained profit? ( 6 )
Prospective method SV assumptions used can impact insurer’s retained profit
if SV assumptions represent exactly future experience (best estimate), then total profit retained will be same as if contract had not surrendered
if SV assumptions same as premium basis assumptions, then profit retained will equal profit made to date
suitable choice - btwn best estimate & premium basis can adjust profit retained in line with desired aim of insurer
possible approach uses blended basis
start with premium basis near entry (retaining profit earned to date)
….and running into best estimate basis closer to maturity
how quickly it runs into best estimate basis depends on how quickly it can start retaining same profit as form non-surrendered contract
How might we determine the assumption basis for SV calcs using retrospective methods? (2)
If retrospective method is used in earlier years
company will need to examine its actual experience for all relevant factors (including investment earnings, expenses, mortality and tax).
may not follow past experience exactly for regular premium contracts (where policyholders are more likely to exercise financial selection against company) particularly regarding investment earnings, to smooth the value.
List the assumptions that will usually be needed when determining a prospective surrender value basis (4)
Interest
Renewal expenses
Inflation
Mortality (including the effect of selection)
Tax (maybe)
