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ch-23

S

Sagar_sagar

Member
Q1. Does companies use to invest in open market cash options (OMCO) ?
Is OMCO a "bond" or (annuity from other provider) ?

Q2. pg 8 section 1.3 topic-"use of option prices"
"At the date of policy issue, all guarantee will normally be expected to be out-of-money i.e they have no intrinsic value......"
My question is if current market rates are sufficient to pay guarantee, then how they will be out-of-money ?

Q3. pg 8 last paragraph "it is possible that a guarantee will not be out of money. for eg. current yields are so low that co. is happy to provide guarantee at high yield in future"
My question is how the co. will be so sure about future higher yield if rates are lower in the market ?

Q4. pg 13 section 2.2 last para "if a life who is in good health and who satisfy the normal underwriting requirement, excersice option, .......will generate considerable additional cost"
my question is why life who is in good health excerise an option would produce little cost than when option is excercised by people in bad health ? according to me everytime option is excercised it will cost the company

Q5. pg 14 section 2.2 "if substantial proportion exercise the option then their subsequent mortality experience will on average be less extreme"
My ques. is why it will less extreme ? ideally larger the policyholder excercising the option, the more it will bite and most strain on company.

Q6. pg. 14 cost of mortality option calculation formula = prop. of lives excersice the option x avg. health of lives of excercising the option
My ques. is how 2nd component i.e. avg. health of lives will be calculated ? what does this signify ?

Q7. pg. 14 under subtopic "factors affecting mortality option" one point is mentioned on encouragement given to policyholder to excerise the option
My ques. is what sort of encouragement is given to policyholder to excerise the option ? why the co. would do so ?
 
Sagar_sagar said:
Q1. Does companies use to invest in open market cash options (OMCO) ?
Is OMCO a "bond" or (annuity from other provider) ?

Q2. pg 8 section 1.3 topic-"use of option prices"
"At the date of policy issue, all guarantee will normally be expected to be out-of-money i.e they have no intrinsic value......"
My question is if current market rates are sufficient to pay guarantee, then how they will be out-of-money ?

Q3. pg 8 last paragraph "it is possible that a guarantee will not be out of money. for eg. current yields are so low that co. is happy to provide guarantee at high yield in future"
My question is how the co. will be so sure about future higher yield if rates are lower in the market ?

Q4. pg 13 section 2.2 last para "if a life who is in good health and who satisfy the normal underwriting requirement, excersice option, .......will generate considerable additional cost"
my question is why life who is in good health excerise an option would produce little cost than when option is excercised by people in bad health ? according to me everytime option is excercised it will cost the company

Q5. pg 14 section 2.2 "if substantial proportion exercise the option then their subsequent mortality experience will on average be less extreme"
My ques. is why it will less extreme ? ideally larger the policyholder excercising the option, the more it will bite and most strain on company.

Q6. pg. 14 cost of mortality option calculation formula = prop. of lives excersice the option x avg. health of lives of excercising the option
My ques. is how 2nd component i.e. avg. health of lives will be calculated ? what does this signify ?

Q7. pg. 14 under subtopic "factors affecting mortality option" one point is mentioned on encouragement given to policyholder to excerise the option
My ques. is what sort of encouragement is given to policyholder to excerise the option ? why the co. would do so ?
Click to expand...
1. The open market cash option allows a deferred annuity policyholder to take a lump sum at retirement instead of the annuity. The policyholder is then free to use this lump sum to buy an immediate annuity from any company. If the insurer invests to match this, they will need a zero coupon bond that matures when the policyholder retires (but this will not match the annuity if the policyholder does not take up the cash option).

2. Consider an endowment with a guaranteed annuity option as an example. Let current market interest rates be 4%. The insurer might then offer a guaranteed annuity based on 3% interest - this is out of the money at the moment as the actual interest rate of 4% is higher than the guarantee of 3%, ie the policyholder would not exercise the option as it is a bad deal.

3. The company will not be sure, so there is a risk that rates remain low. But they may believe that there is a high probability that rates will rise if they are currently extremely low.

4. The policyholder exercising the option will be paying the standard premium rate for the new contract. So there is only a cost to the insurer if the policyholder's health is worse than that assumed in the pricing of the standard rate.

5. The notes are not saying that the total cost is lower. It is just saying that the average mortality will not be so severe (as we will have many reasonably helthy lives as well as some very ill lives).

6. We'll need some data on which to make an assumption by looking at the mortality of policyholders that exercised such options in the past.

7. The company might remind the policyholder by letter for example. The insurer may need to do this for regulatory reasons, eg to be seen to be treating customers fairly. If healthy lives can be encouraged to exercise the option then the insurer will actually make a profit on these contracts (as the standard premium rate will assume healthy lives and will include a profit loading).

Best wishes

Mark
 
Q5. please elaborate

Q7. when policyholder buy the policy he has to opt for the option at that time. opting option means higher premium payable. now no matter whether he exercise the option or not premium would be the same. then how if more healthy lives exercise the option at later stage will benefit the company ?
 
Sagar_sagar said:
Q5. please elaborate

Q7. when policyholder buy the policy he has to opt for the option at that time. opting option means higher premium payable. now no matter whether he exercise the option or not premium would be the same. then how if more healthy lives exercise the option at later stage will benefit the company ?
Click to expand...
Hi Sagar

Q5. If very few policyholders exercise the option they are likely to be in very poor health, let's say their mortality is 400% of the average. If lots of people exercise the option then we still have those with 400% mortality, but we now have people with 200% mortality too. So the average mortality is now maybe 300%, ie the average mortality is less extreme.

Q7. Insurance companies price contracts including a profit margin. So if a healthy policyholder buys the extra contract by exercising the option then the insurer makes a profit in the same way as if a brand new policyholder had bought that contract.

Best wishes

Mark
 
Hi Mark,
I also have a doubt in this chapter.

On page 15, section 2.3 (Valuing a mortality option)
It is mentioned that when a policyholder exercise the option, they will pay exactly same premium as new policyholder that has just passed underwriting on that day.

On page 17 section (Mortality Rates)
It is mentioned that the mortality of those who exercise the option may be assumed to be higher percentage of base mortality table. I.e. policyholder of age x may be assumed mortality of age x+5.

How, both of these assumptions are consistent? If we are assuming higher mortality for lives who take the option, how can we charge the same premium from them as we charge from a policyholder taking a brand new policy with underwriting?
 
Hi Bharti

Bharti Singla said:
On page 15, section 2.3 (Valuing a mortality option)
It is mentioned that when a policyholder exercise the option, they will pay exactly same premium as new policyholder that has just passed underwriting on that day.
Click to expand...

This isn't an 'assumption' - it is a statement of fact. The point of these options is that they give the policyholder the opportunity to increase their cover on standard premium terms, without undergoing further underwriting. This can be a valuable and attractive benefit to potential customers.

Bharti Singla said:
It is mentioned that the mortality of those who exercise the option may be assumed to be higher percentage of base mortality table. I.e. policyholder of age x may be assumed mortality of age x+5.

How, both of these assumptions are consistent? If we are assuming higher mortality for lives who take the option, how can we charge the same premium from them as we charge from a policyholder taking a brand new policy with underwriting?
Click to expand...

Yes: a policyholder who takes out the option (on standard premium rates) but who has higher than select mortality will generate an additional cost for the insurer. The insurer recovers this expected 'option cost' by charging everyone who takes out the original policy (that includes the option) a slightly higher premium. In other words, everyone who takes out the product that includes the option is paying a higher premium for it than someone who takes out an equivalent product that doesn't include the option. And they pay this slightly higher premium (for the product with the option) irrespective of whether or not they end up exercising the option.

Hope that clears this up.
 
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