Hi there, on page 14 of Chapter 32, there is a core reading text that says "When using deterministic and closed form (eg Black-Scholes) methods to value guaranteed options, the traditional approach has been to assume that the take-up rate reflects the financial value of the option only - in other words a high take-up rate is used."
1. Why does 'reflecting only the financial value of the option' mean a high take-up rate is used?
- Is it because we are omitting the fact that some people would not exercise an option even if it is in-the-money (and hence actual take-up would be lower)?
- However, we could equally say that some people would exercise an option even if it is out-of-the-money, wouldn't that result in an even higher take-up?
2. Would assuming a high take-up for options always result in higher provisions (more prudent)? From what I understand, the option to surrender a life insurance policy is also an 'option', but if a high take-up were to be assumed for surrenders towards the middle/end of the policy term (when initial expenses have already been recouped), wouldn't a high take-up (i.e. high surrender) assumption be too optimistic?
Thank you in advance!
1. Why does 'reflecting only the financial value of the option' mean a high take-up rate is used?
- Is it because we are omitting the fact that some people would not exercise an option even if it is in-the-money (and hence actual take-up would be lower)?
- However, we could equally say that some people would exercise an option even if it is out-of-the-money, wouldn't that result in an even higher take-up?
2. Would assuming a high take-up for options always result in higher provisions (more prudent)? From what I understand, the option to surrender a life insurance policy is also an 'option', but if a high take-up were to be assumed for surrenders towards the middle/end of the policy term (when initial expenses have already been recouped), wouldn't a high take-up (i.e. high surrender) assumption be too optimistic?
Thank you in advance!