I still have got some questions under section 4 - Determining the terms to quote 4.1 Equation of policy values Expected profit from altered without- profits contracts the core reading says, the total profit expected from an altered contract depends on the relationship between the profit 'released' at the date of alteration (named it as part one) and the profit expected to emerge, from the date of alteration, over the remaining life of the altered contract (named it as part two). Under these 2 parts, there are sub-bullet points explanations. However, i don't quite understand the whole picture. Can someone explain in details with simple examples? Besides, why realistic prospective value comes into the picture here? I thought for surrender value, and policy value, either altered or unaltered, we should still use the prudent basis? Also, do we use earned asset share as our policy value (if i am not mistaken, i remember policy value is reserve.)? Thanks a lot for your favour! Cheers!
You need to be a little careful in this chapter with the idea of policy value. In this chapter we are thinking more widely than the value placed on reserves, and so the basis we use may not be that prudent. Reserves are set in a prudent way so that the probability of insolvency is very small. So prudent reserves are large. This would be too much money to pay to someone if they surrendered a policy. A fairer amount to pay to a policyholder may be closer to the best estimate of what we expect to pay them if they do not surrender. The key thing to consider is the amount of profit the company will make. A profit is made if the payout is less than the asset share. Imagine a policy with asset share of 100. If the surrender value is 100 then the company has made no profit (which is unfair to the company). The surrender value might be set by taking the prospective value of the policy ie the present value of benefits and expenses less claims. The more prudent the basis the higher the prospective policy value will be. Using best estimate assumptions the policy value may be 80. The company then makes a profit of 20 (= 100 - 80). Using the same assumptions as the pricing basis (which will contain some margins for prudence) the policy value will be higher, say 90. So profit is 10. Using the reserving assumptions (which are very prudent) the policy value could be 110, leading to a loss of 10. The above explanation also applies when considering an alteration by equating policy values.You can use the logic above to work out the profit taken from the old policy (part one in your comments). We then need to look at the profit from the new altered policy (what you call part two). To do this we need to use a different approach to that above. Consider the pricing basis. The more prudent the pricing basis the bigger the premium will be and hence the higher the profit on the policy. If you price the new altered contract using realistic assumptions then the value of the benefits/expenses will be exactly balanced by the premiums, so you make no profit. If the pricing basis contains margins then you'd expect the actual experience to be better than the pricing basis so you'd expect a profit. I hope this helps. Best wishes Mark
A fairer amount to pay to a policyholder may be closer to the best estimate of what we expect to pay them if they do not surrender. For this sentence, i thought a fairer amount to pay to a policyholder should be closer to the best estimate of what we expect to pay them if they surrender? If compared with non-surrender policyholders, their policy value should be higher than the one surrender, where its surrender value should be calculated based on best estimate basis? Sorry that i am still unclear about this bit here. Many thanks for your help.
I was considering the situation where a policyholder wanted to surrender. A realistic estimate of the value of their policy is then the expected present value of the benefits they would have received, plus the expenses they would have incurred, less the premiums they would have paid if the policy had kept going. The value at any given time of the policy should be the same whether it keeps going or is about to be surrendered because in both cases the premiums paid so far are the same. The policyholder should be offered a choice between surrender and continuing which has equal value today. Best wishes Mark
Hi Mark. Thanks for the explanation. So, may i conclude that when we calculate the surrender value for surrendered policyholders, it will be based on realistic basis? (realistic basis = best estimate assumptions, hopefully, i am not wrong). Thanks a lot.
Insurers use a wide range of methods to calculate surrender values. Some use retrospective methods (eg return of premium or asset share). Others use prospective methods (eg using realistic assumptions or pricing assumptions). The more prudent the basis used in the prospective method, the higher the surrender value and hence the lower the profit for the insurer. Hence insurers are unlikely to use their prudent reserves as a surrender value (as they would probably make a loss). Instead they use something closer to a realistic basis, but they will probably still retain some margins. Section 5.2 of the chapter on surrenders describes the choice of basis and its impact on profit in more detail. Best wishes Mark
