Chapter 26: Alterations

Question 1

Two considerations that might make the bases for paid-up values different from the basis for surrender values: (2)

Answer 1

1. the cost of making a policy paid-up may be different from those of paying a surrender value.
2. because the policyholder continues to have a policy in force, the effect of mortality selection may be less than when policies are surrendered.

Question 2

In assessing an alteration method, the principles we might judge it against include: (6)

Answer 2

A - affordability

C - consistency with boundary conditions, e.g. surrender, paid-up, new policy

S - stability

A - avoidance of lapse and re-entry

F - fairness in terms of extracting a suitable amount of profit from the altered policy

E - ease of calculation and of explanation to the policyholder.

Question 3

Some examples of common alterations are: (3)

Answer 3

1. to change the term of an assurance, this would include changing a whole life assurance to an endowment assurance.
2. to alter the sum assured
3. to alter the premium payable

Question 4

Examples of links between special alterations and more commonly occurring alterations: (3)

Answer 4

1. a reduction in the term of a policy to zero is equivalent to surrendering a policy.
2. a reduction in the sum assured of a policy so that no future premiums are required is equivalent to calculating a paid-up sum assured.
3. increasing the sum assured is analogous to keeping the original policy and purchasing an increment policy at current premium rates.

Question 5

What is the key principle for general alterations?

Answer 5

Affordability:

The key principle is that the terms after alteration should be supportable by the earned asset share at the date of alteration so as to avoid the company making a loss.

Question 6

In determining how to calculate paid-up sums assured, the following principles should be considered: (3)

Answer 6

Paid-up sums assured should:

1. be supported by the earned asset share at the date of conversion on the basis of expected future experience.
2. at later durations, be consistent with projected maturity values, allowing for premiums not received.
3. be consistent with surrender values, so that the surrender values before and after conversion are approximately equal.

Question 7

What alteration principle should be considered with regards to stability:

Answer 7

Any methods adopted should be stable in that small changes in benefits should result in small changes in premium, if expenses of alteration are ignored.

Question 8

The proportionate method for paid-up values: (for without-profits EAs)

Answer 8

For without-profit endowment assurances, the paid-up value may be calculated as the basic sum assured multiplied by the ratio of the total number of premiums actually paid to those originally payable through the total term.

Question 9

Equating policy values method:

Answer 9

The value of the contract before alteration, on a prospective or retrospective basis, can be equated to a prospective value after alteration that takes into account the requested changes to the terms of the contract.

Question 10

The total profit expected from an altered contract depends on the relationship between: (2)

Answer 10

1. the method and basis for calculating the policy value before alteration, which determines the profit “released” at the time of alteration, and
2. the method and basis for calculating the policy value after alteration, which determines the profit that is expected to emerge over the remaining term of the contract.

Question 11

The profit “released” at the date of alteration will be: (3)

Answer 11

1. the full expected profit under the unaltered contract, if a realistic prospective value is used for the policy value before alteration.
2. no profit at all, if an earned asset share is used for the policy value before alteration.
3. something in between, if a prospective value using a basis incorporating margins is used for the policy value before alteration.

Question 12

The profit expected to emerge, from the date of alteration, over the remaining life of the altered contract will be: (2)

Answer 12

1. no profit at all, if a realistic prospective value is used for the policy value after alteration.
2. profit corresponding to the margins in the assumptions, if a prospective value using a basis incorporating margins is used for the policy value after alteration.

Question 13

Unit-linked contracts paid-up values:

Answer 13

When converting to paid-up status, the units attaching to the contract at the date of conversion will remain attached, possibly after deduction of any penalty that applies.

Question 14

What alteration principle should be considered with regards to lapse and re-entry:

Answer 14

The terms offered after alteration should avoid the option of lapse and re-entry.

Question 15

What alteration principle should be considered with regards to any increase in benefit?

Answer 15

Any increase in benefit may be subject to additional evidence of health, depending in part on the scale of the alteration and when it occurs in the policy’s lifetime.

Question 16

What alteration principle should be considered with regards to costs?

Answer 16

The costs associated with carrying out an alteration should be recovered.

Question 17

List the two methods that can be used to calculate alteration terms? (2)

Answer 17

1. Proportionate paid-up values

2. Equating policy values

Question 18

The proportionate method on meeting principles: (3)

Answer 18

1. Proportionate paid-up values are usually too high at short durations, because they do not allow for the high initial expenses. At medium durations, on the other hand, they tend to be too low because no allowance is made for investment earnings.
2. The method is unlikely to be consistent with surrender values.
3. The method does, however, have the virtue of being a very simple one to apply and explain to policyholders.

Question 19

What is the principle for the calculation of terms for a general alteration?

Answer 19

For general alterations, the principle of the calculation is that the reserve for the policy held before the alteration should equal the prospective reserve of the altered policy plus the costs of alteration.

Question 20

The equating values method on meeting the principles: (6)

Answer 20

1. The method will produce consistent surrender values immediately before and after the alteration if the same methods and assumptions are used for calculating surrender values.
2. For an extension of term or increase in benefit, use of the current premium basis to calculate the before and after alteration policy values would ensure consistency with the terms for new contracts.
3. There will be consistency between the terms for alterations, surrender values and conversions to paid-up status, if the same bases are used.
4. Assuming the same basis is used for the before and after policy values, the method is stable.
5. It will not necessarily avoid lapse and re-entry and the company would need to check that the premium being charged after alteration is not more than what it would charge for a completely new contract.
6. Provided that the policy value before alteration is not greater than the earned asset share and the basis for the policy value after alteration is not weaker than best-estimate, the alteration terms should be affordable.

Question 21

What are the advantages of the proportionate method: (2)

Answer 21

1. Simple to calculate and for policyholders to understand.

2. Blends into maturity value.

Question 22

What are the disadvantages of the proportionate method: (4)

Answer 22

1. Too high at short durations - will not recover high initial expenses
2. Too low at medium term as not taking into account investment returns
3. Unlikely to be consistent with surrender values
4. Inconsistent with competitors

Question 23

What are the advantages of equating policy value method: (4)

Answer 23

1. Can produce consistent surrender values before and after alteration
2. For increase in benefit/ extension of term can be done on the current premium basis in line with new business
3. Method is stable if basis is the same before and after alteration
4. Affordable depending on basis used.

Question 24

What are the advantages of equating policy value method: (4)

Answer 24

1. Can produce consistent surrender values before and after alteration
2. For increase in benefit/ extension of term can be done on the current premium basis in line with new business
3. Method is stable if basis is the same before and after alteration
4. Affordable depending on basis used.