Margins in lapse rates

In the Q&A Bank there is a question on how and where to incorporate margins against adverse contingencies in the case of reviewing premium rates for a twenty-year without-profits term assurance.

One of the points in the solution is, "Maybe also assume high lapses early on when the earned asset share is negative, and low lapses later on to guard against the effect of selective withdrawal (i.e. only the fit lapsing)."

I understand the first part of assuming high lapses. My question is, how and why does assuming low lapse rates later on guard against the effect of selective withdrawal? Selective withdrawals on term assurances can lead to worse mortality experience than assumed in the premium basis. What is the relevance of an assumption of low lapse rates as a margin against this?

Surely, if we assume the lowest of low lapse rate later on, i.e. a lapse rate of zero, then we assume no effect of lapses on our mortality, which, if there are selective withdrawals, would mean we have underestimated mortality? Please explain the flaw in my reasoning, as I am confused.

Thanks!

 

I have just seen another solution that suggest assuming no future withdrawals may be an appropriately prudent assumption. Under which conditions would this be the case? According to my understanding, withdrawals entail the following:

• smaller profits or even losses
• additional costs being incurred on withdrawal
• fewer policies that contribute to overheads
• possibly a selective effect that can lead to adverse mortality

Why would an assumption of no withdrawals be prudent against any of these?

Thanks!

 

Hi Mark

I am studying the South African equivalent to SP2, i.e. F102. Question 4.1 in the Q&A Bank asks, "Describe how the actuary to a life insurance company would determine a basis for the calculation of its supervisory reserves."

Under the heading "Withdrawals" the first point states, "Have to decide what is an appropriately prudent assumption, e.g. no future withdrawals or all policies withdrawing immediately."

So I am struggling to see how an assumption of no future withdrawals would be prudent. Also, the two extremes given above seem unrealistic. Why would an assumption of "all policies withdrawing immediately" be required? Would this not rather form part of a stress test scenario rather than supervisory reserving?

Thanks!