Chapter 25 - Surrender values

Question 1

List principles that should be considered when calculating surrender values

(11)

Answer 1

• PRE
• Treat both surrendering and continuing policyholders equitably
• At early duration, not appear too low compared with premiums paid, accounting for any projected maturity values
• At later duration, be consistent with projected maturity values
• Not exceed asset shares, in aggregate, over reasonable time period
• Competitors’ surrender values (and possibly also auction values, where applicable)
• Not be subject to frequent change, unless dictated by financial conditions
• Not be subject to significant discontinuities by duration
• Not excessively complicated to calculate, accounting for computing power available
• Be capable of being documented clearly
• Avoid selection against insurer

Question 2

Discuss the influence of PRE when setting SVs in terms of

Discontinuance at short durations (4)

Answer 2

• 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

Question 3

Discuss the influence of PRE when setting SVs in terms of

Discontinuance close to maturity (3)

Answer 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

Question 4

State the main advantages and disadvantages of using the retrospective method for calculating surrender values

Answer 4

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

Question 5

State the main advantages and disadvantages of using the prospective method for calculating surrender values (7)

Answer 5

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.

Question 6

What do we mean by ‘profit retention’ in context of SVs?

What other important feature must be checked when deciding on method for SV calcs?

Answer 6

• 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

Question 7

Comment on use of retrospective method for SVs in relation to retained profit (1)

Answer 7

Retrospective method profit retention => no profit

wouldn’t want to use retrospective method for too long, since SV is equal as asset share

Question 8

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

Answer 8

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.

Question 9

List the assumptions that will usually be needed when determining a prospective surrender value basis (4)

Answer 9

• Interest
• Renewal expenses
• Inflation
• Mortality (including the effect of selection)
• Tax (maybe)

Question 10

Describe the typical terms for surrender of unit-linked contracts.

Answer 10

• Normally specified at outset
  Surrender value normally equals unit-fund bid value, sometimes less surrender penalty
• Penalty could be expressed as proportion of unit-fund value, or as monetary deduction
• Any penalty tends to be relatively large at early policy duration, decreasing over time
• Aims to recover any shortfall at time of surrender, where charges to date have been insufficient to recoup all initial expenses under policy