Exam 2010 April : Q6 (iii)

Discussion in 'SP2' started by st2_taker, Sep 29, 2010.

  1. st2_taker

    st2_taker Member

    Hi all,

    Need immediate assistance.......

    For this question, examiner report is explaining why Conventional method has lower cost than North American Method...

    But I dont quite get the answer... Particularly in conventional method, we assume 100% would take up the option, why is it too optimistic by doing that?

    Thankss
     
    st2_taker, Sep 29, 2010
    #1
  2. Lynn Birchall

    Lynn Birchall ActEd Tutor Staff Member

    In the conventional method, we're determining the option premium assuming that 100% take-up the option as you say. Some of these people will have "better than select" mortality (company makes a profit on these) and some people will have poor mortality (company makes a loss on these).

    If the experience is then that the mortality of those who don't exercise is, on average, better than select, then the company never gets the profits from these policies, but still gets the losses from the less healthy lives who do exercise.

    Hope this helps and that the exam goes well on Monday :)
    Lynn
     
    Lynn Birchall, Oct 1, 2010
    #2
  3. Monkey_Mike

    Monkey_Mike Member

    Hi Lynn

    I understand why the North American method gives a higher cost due to those in good health not subsidising those in poor health. However what I do not understand on this question, is that we work out the take up rate for the N.A method so that the mortality after they take up the option would be equal to Ultimate mortality, so x% have better than ultimate, (1-x)% have worse than ulitmate, but overall they have ulitmate (i.e 100% will have ulitmate - which is the same assumption as post option in the conventional world).

    So why do we get a higher cost under the N.A method when we've made up the take up rate to be equivalent to everyone having ulitmate mortality? I was expecting the costs to be the same because we calculated the take up rate this way.
     
    Last edited by a moderator: Oct 3, 2010
    Monkey_Mike, Oct 3, 2010
    #3

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