The notes say that when you calculate surrender values using a prospective approach if you use the office premium basis then the company retains only the profit made to date, and if you use best estimate future experience then the total profit will be the same as if the contract had not been surrendered. Can anyone explain this, I can't quite work it out at this time in the morning. What basis is the office premium calculated on - is it just slightly prudent?
Hi Claire I'll give it a go . The first point worth stressing is that the surrender value is valued prospectively (i.e. using assumptions about the future) and that the surrender value is what the insurer will pay to the policyholder. So, if the office premium basis is chosen (which would have been used to set the premium originally) then the surrender value effectively includes the profit loadings that the insurer would (should!) have earned had the policy not surrendered. This is now paid to the policyholder meaning that the only profit left to the insurer is what they have earned to date! The profits that would have been generated between the surrender date and the (original) maturity date are paid to the policyholder. Next; If a best estimate basis is used (i.e. free of margins) then this will generate a reduced surrender value i.e. a lower amount is paid to the policyholder (compared with the above). Hence the insurer 'keeps' the profit loadings that it would have earned had the policy not surrendered (in addition to the profits already earned as at the date of surrender). To answer your final question, the office premium contains a profit margin. Regarding the degree of prudence, margins may be in the assumptions themselves or via the risk discount rate (with the assumptions being broadly best estimate). Hope that helps, any comments/queries welcomed
