Hi, could someone please the method of equating policy values and determining the basis for the equating policy values method from the Alterations Chapter ? Thanks in advance.
The equating policy values method sets alteration terms by using an equation of value approach. It equates the value of the old policy with the value of the new policy. So the value of the policy that the policyholder is giving up is exactly the same as the value of the policy they are getting (which sounds fair as long as we choose the assumptions appropriately). The key thing then to consider is the impact of the assumptions on the insurer's profit. This is very similar to the concepts we discussed in the previous thread on the forum, although there is an extra element when considering alterations as opposed to surrenders. We need to break the impact of the assumptions on profit into two parts: the impact on the old policy and the impact on the new policy. Old policy - the value of the old policy being given up is rather like a surrender value. So the profit considerations are identical to the surrender chapter. It might be considered fair to use the prospective value using the pricing assumptions as this gives the insurer the profit accrued so far. If we use a stronger(weaker) basis than this, we will place a higher(lower) value on the policy and the insurer will make less(more) profit. If we use the asset share as the value of the old policy, then the insurer has made no profit from the old policy (which sounds unfair to the insurer). New policy - the value of the new policy is rather like a pricing exercise. Using the pricing basis will give the insurer the same profit as if this was a brand new policy starting at the date of alteration. If we use a stronger(weaker) basis than this, we will require a higher(lower) premium from the policy and the insurer will make more (less) profit - note that this is the opposite way round than for the old policy - a strong basis makes less profit on the old policy and more on the new policy. So to calculate the profit we need to consider the old and new policy separately as above, and then add the two profits together. Using the pricing basis assumptions for both calculations might give a reasonable answer, eg small alterations would give the insurer largely the same profit as they would have got from the original unaltered contract if it had lasted to maturity. I hope this helps. Best wishes Mark
Hi thanks a lot for this Mark. but there are certain areas in the Core Reading in which I am getting confused. “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 profit corresponding to the margins in the assumptions, if a prospective value using a basis incorporating margins is used for the policy value after alteration.”
Hi While calculating the paid up Sum Assured why do we equate it to SV and not the final Sum Assured ?
Sorry for so many doubts. But could you please explain me the question 22.2 from the Practice Questions ?
The equating policy values method equates expected present values. So we need to calculate everything in today's terms, rather than accumulating to maturity. Best wishes Mark
In my earlier post I said that the profit on alteration had two bits: the old policy and the new policy. Your question here relates to the new policy. For the new policy I said that it was just like a pricing exercise. So if you are pricing a new contract using realistic assumptions, then we expect experience to be exactly the same as the pricing assumptions, so the expected profit will be zero. Similarly, if we value the new policy using margins in the assumptions then we expect to make a profit as the premium will have been higher than the best estimate Best wishes Mark.
I'm not sure whether you have the latest version of the notes. Question 22.2 is: A without-profits endowment assurance is to have its term extended. (i) Comment on whether the premium would be expected to rise or fall. (ii) Comment on whether this alteration might lead to mortality selection. Is this the question you are referring to? Also please can you let me know where your difficulty with the solution is. Best wishes Mark
I am referring to the Practice Question Question : Discuss in general terms the following procedures for performing alterations to without-profits policies. You should assume that the company in question calculates premiums for without-profits business on a basis that it expects will produce profit. (i) Equate policy values before and after the alteration on a realistic prospective basis, except for a realistic allowance for the cost of alteration. [4] (ii) Equate policy values before and after the alteration on the original premium basis for the altered contract. sorry for the confusion.
If anyone else is following this thread, this is now Question 22.5. We'll answering it using the approach discussed earlier in the thread by considering the profit made on the old policy and the new policy separately. (i) Realistic assumptions Old policy - using realistic assumptions means taking all the profit that was expected on the original policy if it remained to maturity. New policy - using realistic assumptions means no margins for profit, so no profit from the new policy. (ii) Assumptions with margins similar to the pricing basis. Old policy - the insurer makes the accrued profit using the same logic as the surrender chapter. New policy - we are pricing with margins and so expect the same profit as a new contract sold today. Best wishes Mark
hi Mark , the answer in the book also mentions in respect of the size and term of the policy. Could you please explain ?
A life insurance company uses prospective methods and the following basis for calculating its Exam style surrender values and alteration terms: Mortality: Interest: Expenses: AM92 (lives assumed to be Select at policy outset) 4% pa Renewal: 2% of each premium Alteration or surrender: 120 A without-profits endowment assurance policy was issued exactly fifteen years ago to a life who was then aged exactly 40. The sum assured under the policy is 250,000, payable at the end of the year of death or at the end of the term of 25 years, and the annual premium is 6,200. (i) Calculate the surrender value payable, if the policyholder surrenders the policy just before the premium now due. [2] Instead of taking the surrender value, the policyholder asks to convert the policy into an endowment assurance maturing in five years. The sum assured is to remain the same. (ii) Calculate the revised premium in this question, when calculating the SV why aren’t we deducting the Premiums ? This should be deducted when we are calculating SV on prospective method ? Am I correct ?
Hello Anaayaa This is question 22.6 in the course notes. Yes, when we calculate the prospective value we should deduct the premium. The solution does do this. We deduct 98% of the premium because expenses are 2% of the premium. Best wishes Mark
Hi Anaayaa Yes, we can expand on my earlier post to explain the point on size and term for question 22.5 (i). In my last post I said that we could consider the profit on an alteration in two parts: "(i) Realistic assumptions Old policy - using realistic assumptions means taking all the profit that was expected on the original policy if it remained to maturity. New policy - using realistic assumptions means no margins for profit, so no profit from the new policy." Now let's look at the total profit made. Let's assume that the sum assured is 100 (this is the size) and the term is 25 years. When looking at the old policy this method gives us the same profit as the original policy, ie the profit on a 25 year policy with sum assured of 100. When looking at the new policy we have no profit. So in total we have the profit from a 25 year policy with sum assured of 100. Now let's assume that the alteration is to double the size, so that the sum assured is 200 and the term remains the same. The alteration method appears to be unfair to the company. They make the profit from a policy of size 100, but they are insuring a policy that is twice as big. It would feel more reasonable if the profit made was twice as much if the sum assured is twice as much. Now let's assume that the alteration is to keep the size the same, but the term increases to 30 years. The alteration method again appears to be unfair to the company. They make the profit from a policy of term 25 years, but they are insuring a policy that is longer. It would feel more reasonable if the profit increased as the term increased. So this method only sounds reasonably fair as long as the size and term don't change too much. Best wishes Mark
Thanks a lot, Mark. But in the second part, where the Original Premium Basis is used for both old & New - would it be suitable if Old policy on Realistic & new on Premium - where old policy will earn for the whole term & even the new policy will earn profit as on a new policy Both Premium Basis - why there is a problem if conditions have changed ? would it be suitable if Old policy on premium Basis and new policy on Realistic basis ? Thanks anaayaa
Hello Anaayaa Let's take your three suggestions in turn. We'll assume it's a 25 year policy with sum assured of 100 being altered at time 10. (1) old policy on realistic basis and new on premium basis old policy - using the realistic basis gives the same profit as the original 25 year policy with SA of 100. new policy - using the premium basis gives the profit for a 15 year policy (assuming the term is unchanged) suitability - in total we are making 25 + 15 = 40 years profit, even though the contract is for only 25 year. This sounds like too much profit. (2) old policy on original premium basis and new on premium basis old policy - using the premium basis gives ten years of accrued profit for a contract with SA 100. new policy - using the premium basis gives the profit for a 15 year policy of the new SA suitability - in total we are making 10 + 15 = 25 years profit, which sounds perfectly suitable if conditions are unchanged. However, imagine that interest rates are lower at the date of the alteration. Pricing on the old premium basis may mean we are pricing for a loss. This is going to be a serious problem if the policyholder has asked for a big increase in the sum assured. (1) old policy on premium basis and new on realistic basis old policy - using the premium basis gives the accrued profit from the first 10 years. new policy - using the realistic basis gives no profit suitability - in total we are making 10 + 0 = 10 years profit, but the contract is for 25 years. This sounds like too little profit. So we use the same approach every time. Consider the profit from the old contact. Then consider the profit from the new contract. Add the two together to determine whether this looks fair. Best wishes Mark
Hi m Hi Mark, thanks for explaining. “However, imagine that interest rates are lower at the date of the alteration. Pricing on the old premium basis may mean we are pricing for a loss. This is going to be a serious problem if the policyholder has asked for a big increase in the sum assured.” I get confused how change in interest rates can cause profit or loss and when. Could you please explain ?
Hi Anaayaa Imagine that the old premium basis has an interest assumption of 8%. Current interest rates are lower at 6%. If we set the premium assuming we're going to get 8% but we only get 6% then we won't have as much in assets as we thought we'd get. Best wishes Mark
