Hi Guys. My first question is based on the paid up value plus premium for balance of sum assured. An extract from section 4.3 of the notes reads " If the company calculates paid-up values so that the expected profit is the same as that from an unconverted contract, an excessive profit will be made using this method." I do not quite understand why this is case. Could someone please explain further.
Hi.
When we're looking at profit extraction by an alteration method, we need to look at 2 things:
(1) the value given to the original policy (and so the level of profit the company is expecting to make in respect of that)
(2) the way the terms are being set on the post-alteration policy (and so the level of profit the company is expecting to make on that).
In the case you've posted about:
(1) the PUP is being calculated so that the value of the expected profit to the company is whatever it expected to make on this policy if it hadn't been unaltered
(2) the premium to be charged for the balance of the sum assured is calculated using the premium basis, and so will extract whatever level of profit the company normally loads for in its premiums.
In very non-technical terms(!), this total amount of profit is "whatever the company was expecting to make on the policy anyway + some more profit". This is likely to be an excessive amount of profit.
Note that this situation could be improved if the company did the first part of the alteration differently, in particular if it calculated the PUP value more generously, in a way that extracted only "some" of the expected profit from the policy as originally taken out.
Section 4.4 discusses the profit extracted by using the accumulation of premium surplus.
It reads " The method puts the policyholder into the same position as if he had taken out the contract in its altered form from the original entry date. This may or may not be appropriate." I am struggling to think of situations which could be appropriate or not appropriate. Could someone please shed more light on this?
Thanks.
This is most likely to be inappropriate if the alteration makes the policy a lot bigger or a lot smaller.
Imagine a policyholder originally takes out a policy with quite a small sum assured. Suppose the alteration is to substantially increase the sum assured. A policy with a substantially bigger sum assured would have a substantially bigger premium. This alteration method puts the policyholder in the same position as if he had been paying this substantially bigger premium from the original entry date. This is over-harsh to the policyholder as, prior to the alteration date, he was not receiving the benefit of being insured for the larger amount.
This is more of a problem the longer the original policy is in force prior to alteration. The only time it's worth even considering using this alteration method is for alterations early on in a policy's life.
Hope this helps.
Best wishes
Lynn
