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Cost of Guarantee "Bite"

Discussion in 'SA2' started by Aman, Mar 15, 2022.

  1. Aman

    Aman Member

    Hi

    Scenario: A company sold an endowment product, with a feature that policyholder will be offered guaranteed annuity rate at retirement when the policy matures.

    Now please assume that there is low-interest rate environment at retirement age and the guaranteed annuity rate is attractive for those who want to buy an annuity.

    When it comes to cost of guarantee, which statement would be valid:
    1. because market rates are lower than guaranteed rate, the guarantee is biting when the option is exercised.
    2. if more policyholders are taking up guaranteed annuity rates than the expected policyholders, the guarantee is biting
    or both

    I am of the view that company deducts the charges to cover the expected cost of guarantees. So the actual "bite" to the insurer is when actual guarantees are higher than expected guarantees.

    Let me know what you think

    Thanks
     
    Aman, Mar 15, 2022
    #1
  2. Em Francis

    Em Francis ActEd Tutor Staff Member

    Hi

    Only statement one is true. Biting only occurs when the guaranteed rate is greater than the market rate, and if the guarantee doesn't bite then there is zero cost to the company. The charge is calculated by working out the average time the guarantee bites and by how much.

    Hope this helps
     
    Em Francis, Mar 15, 2022
    #2

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