Surrender value profitability apr 2015 2ii)

[Kiran]

Hi Looking at the examiner report for the above question, im abit confused by the following (in red):

At very early durations, earned asset share may be negative e.g. due to the initial expenses being larger than the premium. In such cases, a loss will be made on surrender since the minimum surrender value that can be paid is zero. After this early duration, the first part of the above expression should lead to a profit being made assuming that there is a profit margin loaded into the pricing basis. However, the company is forgoing any profit that might be expected to emerge in the future.

In addition, if the actual expense cost of surrender is lower than the expense loaded into the surrender value then a profit would be made here. Profit could be defined as surrender value minus statutory reserves, and hence profit emergence would depend on that relationship.

Thanks

 

[Mark Willder]

Hi Looking at the examiner report for the above question, im abit confused by the following (in red):

At very early durations, earned asset share may be negative e.g. due to the initial expenses being larger than the premium. In such cases, a loss will be made on surrender since the minimum surrender value that can be paid is zero. After this early duration, the first part of the above expression should lead to a profit being made assuming that there is a profit margin loaded into the pricing basis. However, the company is forgoing any profit that might be expected to emerge in the future.

In addition, if the actual expense cost of surrender is lower than the expense loaded into the surrender value then a profit would be made here. Profit could be defined as surrender value minus statutory reserves, and hence profit emergence would depend on that relationship.

Thanks

Hi Kiran

The solution to this question is based around the following formula:

Profit = (AS - SV') + (SV' - SV)

where AS is the asset share, SV is the surrender value and SV' is the prospective value of the contract using the premium basis.

This formula is explained in Chapter 21 Section 5.2. The key idea here is that the first term of the formula represents the accrued profit, and the second term represents the future profit that would have been made if the contract continued. The easiest way to see that this is true is by considering the graphs in Section 5.2.

So looking at your first quotation. We are told in the question that the surrender value is calculated prospectively using the premium basis. So SV' = SV, and the second term is zero, ie all the future profit that would have been made is lost. But we would expect the first term to be positive (ie the accrued profit to date) assuming that the premium had been calculated using margins for profit.

Now looking at your second quotation. This is the final line of the solution. It is not connected to the previous sentence (which may have been what confused you). While the rest of the solution has measured profit as the difference between asset share and surrender value, this final sentence says that there are other ways to measure profit. Here it is considering the profit that will emerge in the statutory solvency returns if the surrender value is lower than the reserves.

I hope this helps.

Best wishes

Mark

 

[Kiran]

Thanks Mark