Hi, I understand that having the mortality higher by 5 years in method 2 raises the cost of the option. I'm confused why the other assumption is not mentioned as the fact that method 1 assumes IF policies all will take the option and method 2 says half will. I thought this would raise the cost by a lot too? In the solutions it mentions that the remaining 50% in method 2 is assumed to have standard ultimate mortality (rather than select type) - but this is very different to the other point I wrote in bold. I would appreciate some help and thank you in advance.
Hi Rafi The question is asking why method 2 is more expensive than method 1. The reason you have given (the option take up rate) would be a reason for method 1 being more expensive. The numbers given in the question tell us that the impact of the option take up rate must be quite small compared to the extra 5 years on the mortality rate as method 2 is much more expensive. Best wishes Mark
