Revalorisation Method?!

in the core reading, it states that profit is given to a particular contract is expressed as r% of the contract's supervisory reserve and the premium and benefit increase the same amount.

It sounds like to me like an index-linked policy with the rate of inflation equals to "r%". So what's the point of buying this but not an IL policy? Unless I believe the company will constantly outperform the RPI or whatever index they want to link with. However, given the long term nature of the contract, the performance of the company should be in line with the market, which is kind of the index linked......

Have I gone nuts?!

 

The reasons for buying such a policy over an index linked one would the same as buying any with profits policy over a conventional non profit one. To list a few:
1. Under a IL policy the benefits are guaranteed to increase inline with the RPI and hence the company would charge in its premiums for this guarantee provided. Hence buying a IL policy could be more expensive than a with profits with a revalorisation.
2. One should bear in mind that under a revalorisation method its only the future premiums that increase with the increase in benefits.
3. Different customer needs - a person who needs guaranteed protection against RPI would buy an IL

Hope this helps!
P

 

Thanks. I got the first and third points.

As for the 2nd point, for an IL policy, at their PA, the p/h is informed that their beneift is increased by k%, so their premium goes up by k%. This k% can be RPI or can be say FTSE100 or any other indices. The increase is also for future premium only. I believe not many companies, if any, would have a level gtee premium for the duration of of the policy.

The revolarisation method seems just like an IL policy to me with the index being the profit of the company. Am I getting the wrong end of the stick again? so confusing!!!

 

Hi,

I'll give it a go

A key feature of the revalorisation method is that the guarantee becomes guaranteed (in monetary amount) once added. Under an IL policy, the guarantee is to the index. Were the index to underperform, so would the policyholder's benefits.

The k% will reflect the investment return earned on the assets underlying the contract (i.e. bonds and whatever else the contracts are invested in) - in excess of that already allowed for within the supervisory reserve. Under this method, the savings profts accrue to the policyholders and the insurance profit accrues to the shareholders.

I am generally cautios in making conclusions comparing contract types... it always depends on the policy conditions and is a useful reminder to always consider the specific information given (e.g. in exam questions).

Hope that helps

 

Can I query this? My understanding of index-linked policies is that the premiums are level e.g. if you have an index-linked endowment, your premiums are flat for the whole term but the level of benefit moves with the index.

 

Just wondering- how is this a benefit if the premium also goes up?
Is the policy holder not just paying for the extra SA?

 

They would be if ALL premiums went up in line with the increase in benefit. However, the increase applies to future premiums only - premiums already paid are unchanged.

Think about the situation near the end of the policy term. Perhaps just the last premium goes up by 10, but the benefits might go up by 100 say.

 

Thanks Mike, couldnt get my head around that

 

Hello, sorry I still don't get how is this a benefit to the policyholder.

In general terms, (not sure whether this is the case in europe or not), don't we usually allow customers to increase their sum assured by allowing them to increase the premiums payable in the future via the alterations on the contract? The only difference I see here between an alteration and this bonus declaration method is the underwriting involved in between - where if you do it through alterations you probably have to be underwritten. In alterations of the contract, I believe that the customers don't have to fill up the premium gap for premiums that they have already paid, and this is simply because they paid for what they enjoyed - namely a lower benefit. Whereas if they want a higher benefit in the future, they have to start paying a higher premium now?

I really don't see how this bonus declaration differs from an alteration (in mechanism) and don't see how this can be a benefit to policyholders.

 

For a normal "alteration" increase to sum assured for a without-profits policy, the value of extra premiums payable will be equal to the value of extra benefits granted (ignoring expenses).

But for the revalorisation method for a with-profits policy, the value of increase in benefits exceeds the value of extra premiums asked for and so the p/h gains.

 

Hello, so you mean that for alterations, if the policyholder wants to increase benefit by say $1,000, the premium will also increase by $1,000? If that is so, why wouldn't the policyholder just keep the $1,000 with him/her? I am not famaliar with Europe or US market as I work in Asia, but seems to me that the contracts being sold here, the alterations works just similar to the revalorisation method - where if the policyholder writes to us that he/she wants to increase benefit by 10%, the premium will also end up increasing 10% as a result (letting alone issues with expense and size discounts).

Sorry to have kept asking as this topic does sound rather confusing to me, perhaps because I don't have a European/US working experience...

I also didn't quite get your example on how the policyholder has benefited because they didn't have to pay back the premiums that they originally had to. If my benefit increases starting from today, shouldn't I pay for the increase starting from today as well? Isn't it true that yesterday I was still on a lower benefit (enjoying a lower benefit) and thus I should pay less? If I died yesterday, I would surely get paid the lower benefit and not the higher, right?

 

The total value of premiums would also increase by $1,000, yes.

Let's ignore interest, mortality and expenses for simplicity and say we have a ten-year policy where we pay 10 each year to get 100 after ten years. So that's:

10, ... , 10, 10, ... , 10 | 100

Suppose after five years, we want to alter the policy to double the benefits. We've paid a total of 50 already and want to increase the benefits from 100 to 200. That's an extra 100 to be paid for over five years. So the premiums will be 10 for the first five years and 30 for the next five years. So:

10, ... , 10, 30, ... , 30 | 200

But if a revalorisation policy doubled the benefits after five years, the premiums would only double as well, so we'd have:

10, ... , 10, 20, ... , 20 | 200

This is much better than the alteration scenario and means the policyholder is 10pa better off for the last five years than with the altered policy.

 

I think I have got it. Thanks!

 

Hello Mike,

Very good illustration, drives home the point.

However, where i have a problem is where you said for alterations, total premiums increase by 1000 if benefits increase by 1000.

If i am paying 100 for a 1000 benefit in 5years time, and i choose to increase this by 1000 to 2000 after the first year, i am sure my premium would NOT increase to 350 (100 + (1000/4)).

 

I believe what Mike said was the value of premiums and the value of benefits would increase by 1000. So we're equating policy values.

Open to corrections on this, but I think the seperating factor between an alteration and revalorisation is that your policy reserve does not change on alteration, using equating policy values method (except for differences in the alteration and reserving bases and solvency capital required for increased benefits). This is how it gives consistency for surrender values before and after alteration, assuming they're calculated using a prospective method.

Whereas you do change the reserve on revalorisation method, this reserve change is what adds value for the policyholder.

Am I correct on here?

 

Ok. But note that Benefits and value of benefits are different.