Hi, I had a doubt from the alterations chapter, Section 4.1: "The profit expected to emerge , from the date of alteration, over the remaining life of the altered contract will be: no profit at all, if a realistic prospective value is used for the policy value after alteration" My question is wouldn't the EPV of premiums exceed the EPV of expenses and claims if we have priced the contract to be profitable?
Hi Sayantani, I'll try to answer if I may. It helps in my revision and Mark can correct if I am wrong. If we have priced the contract profitable the EPV of premiums would exceed the EPV of outgoes, however, only at the start of policy term. The alteration would happen some time after the start of the contract. In the equating policy values method we equate the original value of the policy at some point to the prospective value of the altered policy. Positive value of the original policy before alternation suggests that EPV of outgoes exceed EPV of premiums at that point (we can calculate this value as a prospective value for example). This value (after deduction alteration expenses) is basically what we can offer to policyholder to fund the altered policy. Hence, we can offer terms where EPV of premium are less than EPV of outgoes. From this point on it is similar as pricing new contract, if we don't include any margins to our assumptions and use realistic base there would be none profit expected to emerge. Similarly as you would not expect the emergence of profit from contract priced on realistic assumptions. Hope this makes sense. Michal
Hi Michal Thanks for answering this. Yes that's exactly right. Hi Sayantani One thing to note in this chapter is that the calculations being discussed have no explicit profit margins in them. The only way to build in a profit margin is by making the assumptions (interest, mortality etc) more prudent than a best estimate. Best wishes Mark
hi Michal/Mark, Thanks for the reply above. I have another doubt , when we were discussing the thread Models then it was mentioned that for a profitable contract the EPV of premiums will be more than EPV of claims and expenses (on premium basis). Is this true only for outset of policy as Michal mentioned and thats why we are not considering it above or is it because the basis is realistic and thats why we are not considering any profit margins? Sorry getting a bit confused between the bases, realistic and premium and what are the prospective values for each at outset?
Hi Sayantani For a profitable contract, the EPV of premiums will be bigger at the start of the policy than the EPV of claims and expenses. It doesn't matter whether there is an explicit profit margin or implicit margins in the assumptions. Whether this is true later in the contract will very much depend on the circumstances, eg type of contract, size of margins. We are ignoring the profit in the discussion above because we are calculating the value of the new altered contract using a realistic basis, ie it doesn't have any profit margin, so it isn't expected to be profitable. Best wishes Mark
Hi Mark, Thanks for the above reply. Sorry for the confusion. So we are saying that in the case of realistic basis, we don't include any profit margin. But I am confused because when we were discussing negative reserves in the thread Models , you had mentioned that if we use a realistic reserving basis then we would expect profit to occur at outset. Am I missing something here?
Hi Mark, I had another doubt related to the solutions of questions 22.5 and 22.7. The part where it is mentioned that the premium was 6% on the original basis but the new interest rate is 4.5% (which means higher premiums as compared to old basis). Does this mean that the premium basis has been strengthened or weakened as compared to old basis? In other words when we say that basis has been strengthened does it mean we should get more premiums or less premiums? In Question 22.7. it is mentioned that "For example if the premium basis has been strengthened, less profit will be extracted than if the original premium basis were used." Can this be explained with an example related to interest rate and premiums in old and new basis?
Hi Sayantani You need to be very careful to differentiate between a reserving basis and a premium basis. The reference you make to the models chapter is talking about a reserving basis. In the surrender and alterations chapter we are talking about a premium basis. Best wishes Mark
A stronger premium basis would have a lower interest rate assumption and hence a higher premium. However, I wouldn't use the word strengthened in this question. Strengthening the basis implies taking a bigger margin. But in the question the margins sound as if they are unchanged. What has changed is the interest rates available in the market.
At this point in the solution we are talking about placing a value on the old contract. This value essentially represents a single premium that the policyholder uses to buy part of the new altered contract. A stronger basis will lead to a higher value being placed on the old contract and so the policyholder gets a bigger single premium to help by the altered contract and so less money is left for insurer profit. The original premium basis may have been 4% interest and the new stronger premium basis may be 3% interest. Best wishes Mark
