A question in the chapter on Surrender Values asks, "The Core Reading suggests that smoothing investment earnings is more likely for regular premium contracts than single premium contracts. Why?" The solution given states, "Policyholders are more likely to be exercising financial selection against the company when purchasing a single premium contract. It should therefore be longer before a company considers letting them benefit from investment smoothing." I don't know what financial selection is and a 'Ctrl + F' search finds no other mention of the term 'financial selection' in the notes. Is this related to the risks that we try to mitigate with financial underwriting? If so, how is a single premium policyholder more likely to exercise financial selection? Thanks.
Hi Selection involves actions taken by policyholders that would benefit them at the expense of the insurer. Most commonly we see mortality selection where policyholders in poor health try to take out life insurance. Financial selection is actions that are more related to the investments than health. So for example a policyholder may surrender a policy if the surrender value is high compared to the value of the assets, perhaps following a fall in the stock market. With regular premiums the policyholder pays premiums at a variety of times, sometimes shares will be high and other times low, so there is little financial selection regarding the payment of premiums. With a single premium policy the policyholder only makes one investment and so may be attempting to time the market indicating that they are more likely to try to time the market for their surrenders too. Financial underwriting has no connection to financial selection. Financial underwriting involves gaining information on the policyholder's financial status that might indicate problems with lack of affordability of future premiums or mortality selection (if choosing a large sum assured compared to their financial needs). Best wishes Mark
