SP2 - IAI June 2019 paper

[Bharti Singla]

Qus. 1 (i) Discuss the five key factors which would influence the amount of initial capital needed by the company to write a particular policy contract.

One of the factors given in the solution is:
Frequency of Premium Payment –
A lower premium modal frequency results in less premium being available at inception to cover the high initial expenses. This is compensated to an extent by lower reserves as we take credit for the future modal premiums receivable in our reserve calculation. However in case the policyholder dies or withdraws prior to contract termination this high initial expense may not be covered and thus the allowance for future premiums in the reserve calculation does not provide full protection as compared to say a single premium contract where all premiums are paid at the point of sale.

I do understand this point and my understanding is if the premium is payable less frequently, (annually rather than monthly, say) there should be more premium available to pay the initial expenses and hence there will be less capital required. However, the first line of the above paragraph suggests otherwise. Could anyone please clarify?

 

[Mark Willder]

Qus. 1 (i) Discuss the five key factors which would influence the amount of initial capital needed by the company to write a particular policy contract.

One of the factors given in the solution is:
Frequency of Premium Payment –
A lower premium modal frequency results in less premium being available at inception to cover the high initial expenses. This is compensated to an extent by lower reserves as we take credit for the future modal premiums receivable in our reserve calculation. However in case the policyholder dies or withdraws prior to contract termination this high initial expense may not be covered and thus the allowance for future premiums in the reserve calculation does not provide full protection as compared to say a single premium contract where all premiums are paid at the point of sale.

I do understand this point and my understanding is if the premium is payable less frequently, (annually rather than monthly, say) there should be more premium available to pay the initial expenses and hence there will be less capital required. However, the first line of the above paragraph suggests otherwise. Could anyone please clarify?

Hi Bharti

Your explanation sounds right to me. So I'd stick with your wording as it's much clearer. I agree, I would have read the solution as meaning the opposite.

Best wishes

Mark

 

[Bharti Singla]

Hi Mark,

Thanks for the confirmation.

 

[Bharti Singla]

Qus. 3 (iii) of this paper:
An insurance company is considering offering a surrender value in the single premium payment term insurance products. Discuss the methods that can be used to arrive at the surrender values.

Ans. Methods of calculation of surrender values: (i) The retrospective method and (ii) The Prospective method.
The Retrospective method requires sufficient up to date information to calculate earned asset share value for each policy. From the asset share value, the surrender value is arrived. However, this being a term insurance product, the insurer may not maintain the asset shares, hence may calculate a retrospective reserve using a formula.
Suitable parameters, which reflect the experience of the term insurance products in terms of mortality and expenses, cost of surrender, may be required to calculate the retrospective reserve for each duration of the policy.

The second method, the prospective method, estimates the value of future benefits and expenses, net of future premiums due. Suitable parameters estimates, which reflect future expected investment returns, expenses, and mortality experience of the surrendering policyholders and the corresponding costs of surrender, may be required to calculate the prospective reserve for each duration of the policy.

I understand that company may not maintain asset share for term assurance contracts and usually surrender value is not available on term assurance, however if the competitors are providing surrender value on single premium term assurance contracts, then the company may also have to pay the same to its policyholders.
My doubt is why the solution is talking about calculating retrospective and prospective reserve rather than the retrospective and prospective surrender value? What is the relation between reserve and surrender value?

 

[Mark Willder]

Qus. 3 (iii) of this paper:
An insurance company is considering offering a surrender value in the single premium payment term insurance products. Discuss the methods that can be used to arrive at the surrender values.

Ans. Methods of calculation of surrender values: (i) The retrospective method and (ii) The Prospective method.
The Retrospective method requires sufficient up to date information to calculate earned asset share value for each policy. From the asset share value, the surrender value is arrived. However, this being a term insurance product, the insurer may not maintain the asset shares, hence may calculate a retrospective reserve using a formula.
Suitable parameters, which reflect the experience of the term insurance products in terms of mortality and expenses, cost of surrender, may be required to calculate the retrospective reserve for each duration of the policy.

The second method, the prospective method, estimates the value of future benefits and expenses, net of future premiums due. Suitable parameters estimates, which reflect future expected investment returns, expenses, and mortality experience of the surrendering policyholders and the corresponding costs of surrender, may be required to calculate the prospective reserve for each duration of the policy.

I understand that company may not maintain asset share for term assurance contracts and usually surrender value is not available on term assurance, however if the competitors are providing surrender value on single premium term assurance contracts, then the company may also have to pay the same to its policyholders.
My doubt is why the solution is talking about calculating retrospective and prospective reserve rather than the retrospective and prospective surrender value? What is the relation between reserve and surrender value?

Hi Bharti

There is no such thing as a retrospective or prospective surrender value. But the surrender value may be calculated as being equal to either a retrospective or prospective reserve.

Best wishes

Mark