Surrender value Core reading

I am having trouble understanding the following core reading. I apologise for the length of the text, but I am struggling with this

If it adopts a prospective approach then the amount of the profit depends upon the relationship between the assumptions used for the surrender value and those implicit in the calculation of the office premium. Suppose, for the purpose of this discussion, that the allowance for profit is contained solely in margins in the assumptions used to calculate the premium. The profit retained can then be specified as:
(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 surrender value
basis assumptions.

The first part – (EAS – SV') – represents the profit that has been made to date.
The second part – (SV' – SV") – represents the capitalised value of the profit
that will arise in future from the differences between the premium rate
assumptions and the surrender value assumptions.

If the surrender value assumptions represent exactly future experience then the total profit retained will be the same as if the contract had not been surrendered.

If they are the same as the premium basis assumptions then the company only retains the profit it has made to date.

Also, the part where Acted text says..that Profit B is given up..How can they say that?
Rgds,

 

Thanks for the explanation! Much clearer than before. I just had some follow up questions. Could you please respond?

A realistic reserve at outset (just before the first premium is paid) would be the present value of the benefits plus expenses less premiums. But realistically we expect the value of the premiums to be bigger than the benefits and expenses to make a profit. So at outset (just before the first premium is paid), EAS - SV" = 0 - (-expected profit) = expected profit. So if we pay SV" as a surrender value we keep the full profit expected on the original contract.

When you say the EPV (benefits+Expenses)<EPV(Premiums)at time 0 on a realistic basis, do you mean to say that there is an explicit loading for profit on the right hand side at time zero, i.e EPV(Premiums)=EPV(Benefits+Expenses)+Profit?

I understand that there are no margins when calculating SV", while there is no explicit loading while calculating SV' but the profit is released through the margins? Is my understanding correct? If so, then why the differential treatment for loading profit?

 

Thanks

 

Hi Mark

I have a question following to this quoted statement.
If we look at the first line and the last line only on the graph.
Is my understanding in regards of the below three time point correct?!

At the outset, we keep the full amount of profit because EAS - SV" = 0 - (-expected profit) = expected profit.

During the period, EAS grows (1st line) because of profit from the contract started to accumulate. The SV'' (or we can say realistic reserve here) grows because the reserve we need to hold starts to increase to meet the maturity value at the end.

At the end, EAS - SV'' should be equal exactly to the same as the expected profit at the outset?

Of course, here I assume the actual expeirence (in AS) is the same as best estimate assumptions of future experience.

Thanks a lot!!

 

Hello All,

I've been trying to figure out this part for ages and I think I'm almost there. I'm not sure how to quote so I'll just highlight and hope it works. Why is EAS and SV' equal at the outset of the policy? Also I just wanted to verify that under both the realistic and premium basis, we expect the PV of Prems > PV (Ben + Exp).

Thanks again.

 

Thanks so much for the quick reply Lynn. I just want to clarify then the realistic V. The realistic V would be using the office premium but would not have any margins, so is it true that the EPV (B + E) for realistic basis would be lower than the EPV (B + E) under the premium basis, and this is why the realistic reserve is the lowest line of the graph and also why the PV (P) > PV (B + E) on the realistic basis?

Also, an additional question on bases which I think is my problem! For a premium calculated on a prudent pricing basis with margins, these margins would be a source of profit. If the reserves are then calculated with even further prudenece, would this be an additional source of profit (if experience is within margins)?

Thanks again Lynn!

 

Brilliant Lynn! Thanks again!

 

[QUOTE="
However, if SV" is calculated using best estimate assumptions of future experience, then we get the lowest line shown on page 17 (ie realistic V). A realistic reserve at outset (just before the first premium is paid) would be the present value of the benefits plus expenses less premiums. But realistically we expect the value of the premiums to be bigger than the benefits and expenses to make a profit. So at outset (just before the first premium is paid), EAS - SV" = 0 - (-expected profit) = expected profit. So if we pay SV" as a surrender value we keep the full profit expected on the original contract.

I hope this helps.

Mark"/QUOTE]

Hi Mark,

So can I just quickly confirm that at any given time, EAS - SV'' = the present value of the future expected profit on the policy if held till maturity?

Thanks,

Max

 

Thanks Lynn, yes that makes sense now!