Ch 22: Pricing - Options and guarantees

Question 1

Valuing a mortality/morbidity option requires two extra assumptions as part of pricing basis

Answer 1

• Probability that the option will be exercised.
• Expected mortality/morbidity of the lives who choose to exercise the option

Question 2

Three methods to value options and guarantees (mortality and morbidity)

Answer 2

• North American method
• Conventional method
• Stochastic modelling

Question 3

North American method to value mortality/morbidity options

Answer 3

• Requires two additional items in pricing basis:
  * Decrement table for lives who have not yet exercised the option with decrements of death / disability and exercising the option.
• Mortality / morbidity table for lives who have exercise the option, represented by mortality morbidity rates q’x

Question 4

Conventional method assumptions

Answer 4

• All lives eligible to take up the option do so
• Mortality/morbidity experience of those who take up the option will be the Ultimate experience that corresponds to teh Select experience that would have been used as a basis if underwriting had been completed as normal when the option is exercised

Question 5

Limitations of conventional method

Answer 5

• Not possible to use method when tehre are multiple possible dates to take up the option
• Or there is a choice from several options
• Assumption is normally to assume that worst option from financial POV of company is chosen with probability 1.