Hi All, Regarding Chapter 2 EOC question, I had 2 questions: 1. The text says that the guarantee charges would be at their lowest when the guarantee bites. Does lowest here refer to the absolute value of the charges or perhaps the cost of the guarantee when it is in the money? 2. From what I've read, lapses usually occur when the guarantee is out of the money. So, what type of selective lapse would occur with a large fall in stock market prices? Thanks!
Hi In this question, the guarantee bites at any time that investment returns fall below 1% in any particular policy year. 1. Absolute value of charges. Guarantee charges are taken as a % of the unit fund value. So they will be lowest when the guarantee is biting (ie returns are <= 1%), as that is when the unit fund value will be growing at its lowest possible rate (ie 1%). 2. It depends on the specific guarantee in whatever product is being considered. If there is a guaranteed minimum value that only applies at a specified date, eg maturity or perhaps surrender at the 10th policy anniversary, then what you have said will hold: we might see higher surrenders in the period running up to the guarantee date if the guarantee looks it will be out-of-the-money and so not worth sticking around for. But in this question the guarantee holds throughout the policy term, so holds on surrender at any point. Therefore we need to consider that policyholders might be more likely to surrender when markets are down, as the guarantee will protect their surrender value at that point (and they could potentially re-invest at the market low to take advantage of subsequent recovery). Hope that helps.
