Q&A Bank Part 4 Q 4.17

[Avviey]

Hi,

For this question, there are 4 procedures,

number ii) Retrospective earned asset share / Normal premium rates,
from the example on page 26, it says " If we adopted the approach in part ii), we could end up with a sum assured far in excess of the SV offered to the same policy." Can anyone explain this?

number iii) Equate realistic policy values, why would the new calculated premium be larger than the office premium ofr the new small policy if the policy is substantially in size at early duration?

number iv) Equate policy values on the original premium basis, why policy valuse of the current policy on the original premium basis extracts a proportion of profit that increases as duration increases? And why it copes well with either an increase or a decrease in policy size?

I appreciate alot if anyone can help.

 

[Lynn Birchall]

Hello

This topic can get quite confusing I think. The crucial facts to keep in mind are the 3 possible levels of profit from the original policy and the 2 possibilities for the profits from the new policy. Ch 23, page 19 is the course ref for this.

number ii) Retrospective earned asset share / Normal premium rates,
from the example on page 26, it says " If we adopted the approach in part ii), we could end up with a sum assured far in excess of the SV offered to the same policy." Can anyone explain this?

The main point here is that using retrospective asset share as the value of the "pre-alteration" policy is too generous (because it does not take any profit for the company). So, the company is only taking profit in respect of the post-alteration part of the policy.

This is particularly significant for alterations late in the policy term.

In the example, if a policyholder surrendered after 20 years, the SV they would receive would be significantly less than the asset share (as the company would set the SV so as to make profit).

If the policyholder were making an alteration after 20 years using the method suggested, then the value attributed to their original policy would be the asset share. If this was applied as a single premium to buy a new policy for a very short term (eg 1 year), then even with the expenses/profit in the pricing basis, it might still buy a sum assured that was only a little smaller than the asset share (ie the premium).

Comparing the two possibilities, we'd expect the amounts the policyholder got to be quite similar as the situations are fairly similar (SV now, or sum assured in 1 year). But what could actually happen is that the SV is a lot less than the sum assured. (The SV could be a lot less than the AS and the SA only a little less than the AS.)

number iii) Equate realistic policy values, why would the new calculated premium be larger than the office premium ofr the new small policy if the policy is substantially in size at early duration?

Realistic prospective reserve might be negative early on. So, the premium for the new policy has to "make up" this negative amount as well as cover the new benefits under the policy. So, it might be bigger than the normal premium if someone just started from scratch and took out a new policy.

number iv) Equate policy values on the original premium basis, why policy valuse of the current policy on the original premium basis extracts a proportion of profit that increases as duration increases? And why it copes well with either an increase or a decrease in policy size?

This is actually very similar to the logic in the surrender value chapter about how much profits different surrender value methods would extract - it's like "Profit A" on page 17 of Chapter 22. If re-reading that doesn't help, happily post again to say so and I'll try and explain a bit more fully.

Best wishes
Lynn

 

[Avviey]

Thanks alot, Lynn.