Chapter 23 - Alterations

[tbs1984]

Hi, I have a couple of questions as follows:
1) Under Chapter 23, page 2, section 1.1

The core reading reads,
Two considerations might make the bases used for the calculation of paid-up values slightly different from the bases used for surrender values.
Firstly, the costs of making a policy paid-up may be different from those of paying a surrender value
Secondly, because the policyholder continues to have a policy in force, the effect of mortality selection may be less than when policies are surrendered.

For the first one, the costs here mean that administration costs and policy issuance costs? Please correct me if i am wrong or please provide more details if any.

For the second part, may i know why the effect of mortality selection is less than surrendered policies? Can someone explain the reasons/ examples?

For question 23.1, the answer says that since mortality selection should be more intense for surrender than paid-up policy, the surrender value basis has lighter mortality assumption than paid-up. May i know the reason for that? Lighter mortality assumption means the mortality rate used from the table is less than 100% (i.e low probability of dying)?

Many thanks for your help! Look forward to getting a greater picture!

 

[cjno1]

For the first one, the costs here mean that administration costs and policy issuance costs?

Yes, just the administration expenses the company incurs.

For the second part, may i know why the effect of mortality selection is less than surrendered policies? Can someone explain the reasons/ examples?

If someone is particularly healthy, they are more likely to surrender a life insurance policy since they may have less need for the protection. An unhealthy life is less likely to surrender because the insurance is much more valuable to them. This means a high proportion of surrenders are "healthy" individuals, meaning the mortality experience of those left behind is worse. This is called selective withdrawals.

However, the main reason for people making a policy paid-up is because they can no longer afford the premiums. This is just as likely to happen to healthy individuals as unhealthy ones, so the selective withdrawal effect is much less.

That's how I learned it anyway, there might be other reasons!

 

[tbs1984]

Have been ill for a week. Sorry for the late reply.

Thanks cjno1. It is clear now.

 

[tbs1984]

Can someone / tutor explain the question 23.1? Many thanks for that.

 

[bensondros]

i'm guessing..

the SV in this case is calculated using prospective policy value. Since mortality selection is more intense, we want to impose a heavier 'punishment' for surrendering, thus extracting more profit from the policy. To do that, we offer lower SV so that AS-SV is larger.

If the mortality basis is lighter, there is lower probability of the PH dying and hence making a claim, so the prospective policy value is lower. Therefore SV is lower and we achieve our aim.

can someone else verify this?

 

[Mark Willder]

the SV in this case is calculated using prospective policy value. Since mortality selection is more intense, we want to impose a heavier 'punishment' for surrendering, thus extracting more profit from the policy. To do that, we offer lower SV so that AS-SV is larger.

If the mortality basis is lighter, there is lower probability of the PH dying and hence making a claim, so the prospective policy value is lower. Therefore SV is lower and we achieve our aim.

can someone else verify this?

Yes this is a good explanation of question 23.1. A policyholder is inlikely to surrender a policy with a valuable death benefit if they have poor health, so we use light mortality to calculate surrender values.

If the healthy surrender then we are left with the less healthy lives who are more likely to claim. So yes, we "punish" the surrenders with a low surrender value to help cover the extra costs of the remaining lives.

Best wishes

Mark

 

[mammam87]

Hello,

I understand the explanation above, but I hope someone can help out with this! In question 23.1, the product is a whole of life policy, which pays out regardless of when the policyholder dies. Thus, if a member surrenders, I'm not exactly sure why it would have a relationship to the health of the member (i.e. why would the member surrender just because he's healthy, since the policy will pay out anyway, just maybe later as his life expectancy is longer).

Thanks very much!

 

[cjno1]

You're right, the policy will pay out eventually to everyone, but the timing of the payment will make it much more valuable to an unhealthy life than a healthy one.

For example, imagine there are two "similar" (in the eyes of the insurer) policyholders who take out whole life policies and are paying £50 a month for a £10,000 benefit on death.

If one of the policyholders is unhealthy, and doesn't expect to live more than e.g. 5 years, then this policy is very valuable (total premiums = £3,000), so they are very unlikely to surrender.

If the other policyholder is extremely healthy, and may expect to live 20 years or more, then this policy is not very valuable at all (they will pay over £12,000 in premiums for the £10,000 benefit).

Also, a healthy life may be able to surrender and then get a cheaper policy elsewhere. An unhealthy life cannot do this.

So, even though the policy pays out to everyone regardless of when they die, it is still more likely that healthy lives will surrender and unhealthy ones will keep paying premiums, giving the selection effects.

 

[mammam87]

Thanks cjno1! that makes sense!