Hi I am trying to understand the effect on UL business surrender values if a Life insurer was taxed on I - E basis and then moves to being taxed on Premium income. I have read that - surrender values will be lower for short durations IF - surrender values will be higher for longer durations IF both relative to the I - E basis. Why would this be? Thank you, Rachael
I think this refers to a question in the X2 assignment? The question also states that the tax rate on premium income has been set so that total tax take is broadly unchanged. That being the case, there must be some situations where more tax is payable than previously and some where less tax is payable than previously. We need to consider the relative proportions of premiums and investment earnings that accumulate to form the surrender values. At shorter durations these would comprise proportionately more premium (and less investment earnings) than at longer durations (more investment earnings relative to premiums) due to the compounding effect. Hence shifting from taxing investment earnings to taxing premiums will be better for SVs at longer durations than for SVs at shorter durations.
Hi Lindsay, Yes it is, I didn't want to give any spoilers ;-) This makes sense, thank you. And thank you for highlighting the hint in the question for me to look for situations where more tax is payable than previously and vice versa. Thank you, Rachael
