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QA4.7

S

St2_2016

Member
Hi guys, I have two questions:

1. The solution (i) says "If very early on, a policy is reduced substantially in size. The new calculated premium may be larger than the office premium for the new small policy"

I don’t understand how the reduced policy size plays a part here.
Also, why the new calculated premium is larger than the office premium for the new small policy? I thought it’s smaller. My logic is:
· The new calculated premium is calculated based on current realistic value (realistic so no margin).
· The office premium for the new small policy is based on current pricing basis (so have margin).
· So new calculated premium is smaller than office premium.

2. The solution (ii) says “the method copes well with an increase in the size of the policy: using the premium basis for the new policy will extract more profit”
Again, I don’t understand how the increase in the size of policy can affect the original premium basis for the new policy because I thought the original premium basis is unchanged regardless of the policy size.

Thanks heaps guys!!
 
Tricky - need to get your head around pages 15 and 16 of chapter 22.
Your first bit of logic misses the fact that the first calculation is an alteration. We aren't just simply valuing the new contract realistically (which would give a lower value as you suggest), we are also using the current value of the old contract, hence equating policy values. If you value the old one realistically you are implicitly releasing the total value of the profit you expected to make on the original contract. If this is done early on then this might mean we have a negative policy value. So the new premium effectively is the realistic value of benefits plus a large profit loading for the large original policy.

2. I think you've mis-interpreted. Original basis is fixed - agreed. Using premium basis for the value of new policy expects to release any margins in the basis in future. The margins are likely to be im0plicitly linked to the size of the policy. Eg 2% of a big number > 2% of a small number. So if policy gets bigger, future profit margins will be bigger than they were originally. And vice versa, which seems sensible.

Hope that helps
 
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