Decreasing Term Assurance

[calibre2001]

Of the Core Reading for ST2/SA2 under term assurance there is a description on withdrawal risk which reads:

There will also be a financial risk from withdrawals at times when the reserve is negative. The risk is exarcerbated in the case of decreasing term assurances if the cost of benefit exceeds the premium being charged. This is mitigated sometimes by limiting the premium-paying term to less than policy term.

My understanding of decreasing term assurance products is as follows:
-Premiums collected are linked to the original sum assured
-So negative reserves are very possible because premium is forever linked to the original SA whilst the SA is reducing with time (PV premium>PV benefits)
-negative reserves are a deceiving 'asset' because its only an asset if realised. So if the policy is lapsed, we lose this 'asset' and end up with lower profits or losses instead

What I'm not clear is how limiting the premium paying term reduces lapse risk from the Core Reading.

Is it saying that by limiting the payment term we collect the premiums sooner (possibly because it has to be repriced higher to meet the profit requirement) and therefore the impact of lapse risk is less?

Or is it saying that it influences policyholder behaviour i.e. less incentive to lapse since premium savings from lapsing (assume no CSV paid for lapsing) is less than expected?

Many thanks.

 

[mugono]

Of the Core Reading for ST2/SA2 under term assurance there is a description on withdrawal risk which reads:



My understanding of decreasing term assurance products is as follows:
-Premiums collected are linked to the original sum assured
-So negative reserves are very possible because premium is forever linked to the original SA whilst the SA is reducing with time (PV premium>PV benefits)
-negative reserves are a deceiving 'asset' because its only an asset if realised. So if the policy is lapsed, we lose this 'asset' and end up with lower profits or losses instead

What I'm not clear is how limiting the premium paying term reduces lapse risk from the Core Reading.

Is it saying that by limiting the payment term we collect the premiums sooner (possibly because it has to be repriced higher to meet the profit requirement) and therefore the impact of lapse risk is less?

Or is it saying that it influences policyholder behaviour i.e. less incentive to lapse since premium savings from lapsing (assume no CSV paid for lapsing) is less than expected?

Many thanks.

Hi I'll give it a go

From my understanding, I took the use of the term 'reserve' to mean the policy's underlying asset share. The asset share is typically negative to begin with (certainly the case I would imagine for regular premium contracts)and so by limiting the premium paying term, the premiums will be higher and therefore the asset share will be negative for a shorter period of time.

This will consequently reduce the company's (actual) loss from a policy lapsing.

So yes, I agree with your first hypothesis

I think the key 'issue' with decreasing term assurance policies is that (as you state) the sum assured/benefit falls over time but the premium remains level.

Without making a 'tweak' to the premium payment term there will likely come a point when the policyholder will be better off lapsing as the amount of premiums they will pay will exceed the value of benefit they will receive.

Aside: I think that with many questions it's important to be clear at the outset whether your logic is in respect of a policy's prospective reserve or the asset share.

I admit I haven't looked at the relevant section of the notes but from memory, the notes are commenting with respect to the asset share.

Hope that helps

Have another think about your statement of 'premiums being forever linked to the benefits'. It is not clear what you exactly mean by that but I have not considered it given that was not part of your question.

The premium would have been set given (e.g.) expenses (including commission), benefit levels, profit margins considerations etc. So as you can see, the premium would consider more than just the level of benefits payable on claim.