X2.3 (v)(b) The solution mentions that positive correlation (20%) between lapse and mortality is justified for UL business if there are guaranteed death benefits. How are the two risks related for the above scenario? If there is guaranteed death benefit for UL contracts, why would it trigger selective withdrawal if mortality increases? Logically, if mortality increases then people will automatically get the GMDB. In the early years of the policy, this guarantee would bite for the company. Why would anyone selectively lapse their policy?
My thoughts are the insurer has control on the charges they levy policyholders. So if experience worsens they can review the charges upwards to reduce possibility of future losses being caused by mortality worsening hence guarantee biting. This therefore makes the charges expensive for the policyholders and reduces rate at which the fund grows as more charges will now be deducted. Those who are less at risk and less likely to benefit from the guarantee then selectively lapse their policies.
