Chapter 22 - Surrender Values

[Riya Arora]

Hi all,
I am having trouble in understanding the Section 5.2 surrender profits

It says,

If these surrender value assumptions exactly represent future experience, then the total
profit retained will be the same as if the contract had not been surrendered. If they are the
same as the premium basis assumptions, then the company only retains the profit it has
made to date.

From my understanding, by prospective method, SV is BEL at penalized interest rates so that PV is smaller than the actual

But I fail to understand this statement and the graphs in the section.

 

[Riya Arora]

Please help me understand the following two statements given on page 13 & 14

Retention of profit
If these surrender value assumptions exactly represent future experience, then the total
profit retained will be the same as if the contract had not been surrendered. If they are the
same as the premium basis assumptions, then the company only retains the profit it has
made to date.

Choice of basis
One possible approach is to use a blended basis that starts with the premium basis assumptions near to entry and runs into the best estimate assumptions nearer to maturity. How soon it runs into the best estimate assumptions will depend upon how quickly it feels it can start retaining the same profit as from a non-surrendered contract.

 

[Mark Willder]

Hi all,
I am having trouble in understanding the Section 5.2 surrender profits

It says,

If these surrender value assumptions exactly represent future experience, then the total
profit retained will be the same as if the contract had not been surrendered. If they are the
same as the premium basis assumptions, then the company only retains the profit it has
made to date.

From my understanding, by prospective method, SV is BEL at penalized interest rates so that PV is smaller than the actual

But I fail to understand this statement and the graphs in the section.

Hi Riya

The course doesn't say that the SV is "BEL at penalized interest rates". I wonder whether that is the approach that you have seen used at work. There's lots of different ways to calculate the SV in practice, but this isn't one of them that is mentioned in the course. I think this might be where your confusion lies - you are thinking that the notes are describing what you do at work, when in fact they describe something different.

Best wishes

Mark

 

[Mark Willder]

Please help me understand the following two statements given on page 13 & 14

Retention of profit
If these surrender value assumptions exactly represent future experience, then the total
profit retained will be the same as if the contract had not been surrendered. If they are the
same as the premium basis assumptions, then the company only retains the profit it has
made to date.

Hi Riya

I'll look at your two questions separately.

If we use assumptions that reflect our best estimate of the future experience then our surrender value will have exactly the same value as the future benefits we expected to pay out. So we get exactly the same profit as we would have received if the contract had not been surrendered.

If instead we use the assumptions from a prudent premium basis (with no explicit profit margins) as described in the course, then the surrender value will be higher because the margins in the basis make the value larger. Let's say it is a ten year contract. At the beginning we have priced to get ten years of profit margins. Consider a 10 year contract. When we calculate the SV we get a higher SV due to the margins in the future premiums. So if we calculate the SV after 3 years, the SV is increased by the remaining 7 years of profit margins, these go to the policyholder, so the insurer only keeps the 3 years of profit margins earned so far.

I hope this helps.

Best wishes

Mark

 

[Mark Willder]

Please help me understand the following two statements given on page 13 & 14

Choice of basis
One possible approach is to use a blended basis that starts with the premium basis assumptions near to entry and runs into the best estimate assumptions nearer to maturity. How soon it runs into the best estimate assumptions will depend upon how quickly it feels it can start retaining the same profit as from a non-surrendered contract.

Hi Riya

You can see how the blended approach works by looking at the graph.

It may be argued that it is unfair to policyholders if the insurer keeps all the original profit on the surrendered contract in the early years. In my 10 year example above, the SV after 3 years would be very low if the company had taken the full 10 years of profit. So in the early years at least, it is more common to calculate the SV on the premium basis.

So there's an argument that the premium basis should be used for all surrender values. So if the policy surrendered after 9 years, the insurer should get 9 years of profit. However, this is probably unfair on the insurer as policies surrendering early on are likely to make a loss (as the surrender value should be negative when the asset share is negative, but negative surrender values are not possible). So it can be argued that making the full 10 years profit on a surrender at time 9 is reasonable so that the insurer can recover the losses from the very early surrenders.

Best wishes

Mark

 

[Riya Arora]

Thanks mark, for the clarification!

I have this further doubt in chapter 30 of SP2 which says

"If using a realistic basis, the initial reserves would be much lower, perhaps even negative. The reserves should reflect the future profits expected from the business, which should offset the initial costs involved (otherwise there is something wrong with the pricing basis)."

Can you please help me visualise this?

 

[Mark Willder]

Thanks mark, for the clarification!

I have this further doubt in chapter 30 of SP2 which says

"If using a realistic basis, the initial reserves would be much lower, perhaps even negative. The reserves should reflect the future profits expected from the business, which should offset the initial costs involved (otherwise there is something wrong with the pricing basis)."

Can you please help me visualise this?

Hi Riya

To make a profit, the present value (at the point of sale) of the premiums should be bigger than the present value of the claims and expenses. As the reserve is the present value of the claims and expenses less the premiums then we would realistically expect this to be negative in the early stages of the policy (reflecting the profit that has been loaded into the future premiums).

Best wishes

Mark

 

[Riya Arora]

Got it. Thanks!

 

[Riya Arora]

Hi,

Page 9 Question

Outline the disadvantages of this asset share method for without-profits business.

"Basically for without-profits, no profit is retained by the insurer."

What is the context of this line?

 

[Mark Willder]

Hi,

Page 9 Question

Outline the disadvantages of this asset share method for without-profits business.

"Basically for without-profits, no profit is retained by the insurer."

What is the context of this line?

Hi Riya

The asset share represents the accumulated cashflows of a policy. If the insurer pays this as the surrender value then there is nothing left to make a profit. But making a profit is the whole point of selling without-profits business.

Best wishes

Mark

 

[Riya Arora]

Hi,

It says that the retrospective method of calculation does not take account of future profit, and hence we can not ensure equity between surrendering and existing policyholder.

The same concept has been introduced in with-profit contracts also, which says something regarding equity between new and existing policyholder. (how loading 50% of the previous bonus rates for New business can lead to inequity, in this context or some other)

I am having a hard time understanding both these concepts. Please help me understand in which sense are we talking about equity in both cases.

 

[Mark Willder]

Hi,

It says that the retrospective method of calculation does not take account of future profit, and hence we can not ensure equity between surrendering and existing policyholder.

The same concept has been introduced in with-profit contracts also, which says something regarding equity between new and existing policyholder. (how loading 50% of the previous bonus rates for New business can lead to inequity, in this context or some other)

I am having a hard time understanding both these concepts. Please help me understand in which sense are we talking about equity in both cases.

Hi Riya

Equity in these cases means that if policyholders have paid the same premiums then the value of their policies should be the same.

So considering your surrender example, two policyholders have paid the same premiums so far (one person surrenders and the other continues), so it would be equitable if the surrender value paid out was the same as the prospective value of the continuing the policy. This is unlikely to be the case if the surrender value is calculated retrospectively.

If you provide me with the reference for your with-profits quote then I could say more for that.

Best wishes

Mark

 

[Riya Arora]

Hi Riya

Equity in these cases means that if policyholders have paid the same premiums then the value of their policies should be the same.

So considering your surrender example, two policyholders have paid the same premiums so far (one person surrenders and the other continues), so it would be equitable if the surrender value paid out was the same as the prospective value of the continuing the policy. This is unlikely to be the case if the surrender value is calculated retrospectively.

If you provide me with the reference for your with-profits quote then I could say more for that.

Best wishes

Mark

Got it, Thanks.
For the with profit one, can you refer the core-reading question on page 33 of setting assumptions.

Also, I meant to ask are there still only 5 acronyms in SP2 revision notes?

 

[Mark Willder]

Got it, Thanks.
For the with profit one, can you refer the core-reading question on page 33 of setting assumptions.

Also, I meant to ask are there still only 5 acronyms in SP2 revision notes?

Sorry Riya, i'm not seeing a question on page 33. Are you using an old set of notes.

Yes there are 5 mnemonics in the revision notes.

Best wishes

Mark