April 2022 Q4 (v)

[Nicholas_B]

The suggested answers in the examiner report mentions:

1) [because in reality, the overheads will not change if this policyholder surrenders and the overheads will still be incurred meaning the company will make a loss..]

2) [..Claims expenses should be a deduction from the SV as opposed to being included in the total expenses and therefore increasing the SV. It may be more suitable to only allow for variable costs to be an addition to the SV..]


1) Surrenders should lead to a smaller pool of in-force policies remaining, and I agree that overheads do not vary with the number of policies in-force, and so should lead to higher per-policy overhead cost. So does that mean that the level annual expense component in the prospective SV formula below specifically refers to variable expense? (i.e. expenses that vary with the level of business/policies in-force)

2a) Why is it that claims expenses is suggested as a deduction from the prospective SV? The formula for the prospective SV in core reading explicitly states that it is : EPV(Future benefits) +EV(level annual expense) + EPV(normal claims expenses) - EPV(future premiums) - surrender costs. So this seems contradicting.

2b I find it difficult to distinguish the difference between claims expense and surrender costs in the context of a surrender of an endowment assurance, aren't they the same? And if so, why is one being added to the prospective SV and the other deducted?


Thanks in advance.

 

[Lynn Birchall]

Hi Nicholas

1) I'm not sure I'd go quite that far in terms of generalising. So, I'd say yes in the sense that changing the annual expenses to reflect just variable expenses is being suggested as a possible improvement to the company's approach in this question. I wouldn't go so far as to say that we should always assume that the formula given in the Core Reading is incorporating just variable expenses though - safer to see how expense terms are defined in any given case.

2a) and b) Taking these together because, as you suspect, the terminology used is the main difficulty here I think.
In the formula in the Core Reading, normal claims expenses are expenses incurred on death/maturity claims. (Therefore these expenses would only potentially be incurred if the policy remained in force.) In the Core Reading, surrender costs are the only being incurred because the policy is being surrendered, ie not remaining in force. These are the surrender expenses. Hopefully the logic of the different signs in the Core Reading formula then make sense, ie adding renewal and death/maturity claims expenses (no longer need to reserve for these as policy will no longer be inforce), subtracting surrender costs/expenses as these are incurred on surrender and should reduce the SV paid.

In relation to Q4(v), I interpret the point in the examiner report as being that this method is doing something unsuitable because it is not taking account of these different types of expenses and is simply adding them all in. Whereas, as in the Core Reading, the surrender costs/expenses should be taken separately and subtracted.

Hope this helps unpick things
Best wishes
Lynn

 

[Nicholas_B]

Thanks Lynn for your explanation.