Hi , Could anyone please help me with the 5 conditions mentioned in Page 17 of Chapter 21 - Surrender Values ? Thanks in advance.
Hello Anaayaa I'm afraid I'm having difficulty finding the 5 conditions you mention in Chapter 21. Page 17 covers determining a basis, and I can't see a mention of conditions there. Perhaps you are using an older version of the course notes. Please could you give me some more information about your question and I will be happy to answer it. Best wishes Mark
Hi Hi mark, Just above the determining the basis, there are 5 situations mentioned. I am referring to those. thanks
Thanks. I can now see the bit you are referring to. It's the 5 situations at the end of Section 5.2 on page 16. Section 5.2 is suggesting that using the original pricing basis might give a fair surrender value in terms of the amount of profit that the insurance company makes. However this only applies if actual experience is the same as expected. The 5 situations then look at cases where actual experience isn't as expected and so considers whether we need to change the surrender value. In situation 1, the interest rate has increased. So the matching bonds have fallen in value. We now have lower assets, so we must pay a lower surrender value. In situation 2, the interest rate has fallen. So the matching bonds have increased in value. So we should pay a higher surrender value. The realistic value of the policy to the policyholder has gone up (as we discount the benefits at a lower interest rate), so they will expect a higher surrender value. In situation 3 the interest rate has fallen, but the insurer was holding cash, so their assets are unchanged. In this case the insurer cannot afford to increase the surrender value without making a loss. Situation 4 looks at changes in interest rates early in the policy term. As the contract is regular premium then the assets will be small at this stage so the assets won't match the liabilities (this is the reinvestment risk due to future premiums). It is likely that the insurer will make a loss on early surrenders regardless of what interest rates do as the policyholder will expect some form of return of premiums, but the asset share will be very low or could even be negative. Situation 5 points out that single premium policies can be matched early on - there are no future premiums for any reinvestment risk. So single premium contracts will be similar to situations 1 and 2 , even if the surrender occurs early. I hope that clarifies what we were trying to say there. I'm sorry for the confusion. Best wishes Mark
Thanks a lot, Mark. Its clear now. Just could you please explain this line you have mentioned " original pricing basis might give a fair surrender value in terms of the amount of profit that the insurance company makes"
The first graph in Section 5.2 shows the profit broken down into two parts. Profit A is the accrued profit, given by the asset share less the prospective value on the pricing basis. Profit B is the expected future profit given by the prospective value on the pricing basis less the prospective value on the realistic basis. Consider a contract that is surrendered half way through its term. A surrender value equal to the asset share would mean no profit for the insurer - this could be considered unfair to the insurer as it makes no profit to reward it for the work it has done and the risk it has carried. A surrender value equal to the prospective value on a realistic basis would mean the insurer makes the same profit as for a contract that reached maturity (ie profit A plus profit B) - this could be considered unfair to the policyholder as the insurer makes the full profit even though it hasn't done all the work or been exposed to the risk for the full term. So maybe a fairer profit would be just profit A. This would give the insurer the accrued profit. It would make around half of the full profit which could be considered to be fair as it has done about half of the work. This is achieved by paying a surrender value equal to the prospective value on the pricing basis. I hope that helps to explain this section. Best wishes Mark
A life insurance company is currently reviewing its surrender values for regular premium Exam style without-profits endowment assurances. (i) Describe the most important objectives of the company when determining surrender values. [5] (ii) Propose with reasons a suitable approach to calculating surrender values. [8] (iii) Describe: the problems caused by a sharp increase in interest rates in the context of surrendering policies how the approach recommended in part (ii) would cope with such problems. could you please explain me part 3 of this question ? thanks.
Hello Anaayaa An increase in interest rates will mean a fall in bond prices. So the assets held by the insurer will fall in value. How much the assets fall will depend on their term. If we calculate the surrender value as a prospective valuation, then we will need to reduce the interest rate so that the surrender value falls to be consistent with the lower asset values. Best wishes Mark
Hi Mark, Just looking at your answer. The core reading says that the prospective value values future benefits at the higher rate which would result in a lower surrender value. However you say that interest rates need to be reduced in order to reduce surrender values. Could you clarify please? Thank you!
Sorry about that. This was a typo. I should have said "we will need to increase the interest rate" to be consistent with my comments on the previous line about an increase in rates. Thanks for pointing this out. Mark
