Ch 25: Surrender values Flashcards
(31 cards)
Summary card
- Surrender Principles – PALACE DICE
*PRE
*Asset share
*New business disclosure and competitive considerations
* Change in surrender scales over time and by duration
* Ease of application
* Selection against the company
* Surrender and re-entry - Methods of calculation
- Analysis of methods
- Calculation of values and profit on surrender
- Choice of method
- Retention of profit
- Determining a basis for retrospective method
- Determining a basis for prospective method
- Unit linked contracts
What do we mean by ‘surrender’? (1)
What kind of reserves is it important for us to consider to assist in setting surrender values? What do we compare these to? (2)
Surrender relates to policyholders terminating contracts early in return for an immediate cash payment
- Insurer no longer needs to hold a reserve for the contract, hence surrender value can be paid
It is normally useful to consider prospective and retrospective reserves when calculating surrender values.
- We compare these reserves to the asset share at time of surrender
What type of contracts do we mainly consider surrender values for in this course?
We mainly consider surrender values for conventional without profits contracts
For each of these, why may (or may we not) offer SVs?
Endowmwnt/whole of life (2)
Endowment/whole of life
- reserves increase with policy duration, hence SV can be paid
- SV (and reserves) typically increases towards sum assured
For each of these, why may (or may we not) offer SVs?
Term assurance (5)
Term assurance: usually no surrender value because
- reserves always very small compared to sum assured
- cost of selective withdrawals => reduced if no SV
- recoup losses on early lapses (when ass share negative) by making some profit on later lapese (when ass share positive)
- asset shares quite volatile, so difficult to devise SV which treats PHs fairly in relation to this
- ass shares can be negative and/or decreasing at later durations/towards end of policy=> hard to sell this to PHs
For each of these, why may (or may we not) offer SVs?
Immediate annuity (2)
Immediate annuity: usually no surrender values because
- PHs would want to surrender only if think they’ll die soon
- hence, giving SV would => improved longevity of remaining lives=> big cost
- also, legislation may not allow this, if tax privileges were granted for certain contract types providing long term annuity income in retirement to releive burden on state
- if SVs given, people would use these contracts as savings vehicle to benefit from tax concessions = defeating goverment aims
List principles that should be considered when calculatings surrender values
(11)
- PRE
- Treat both surrending and continuing policyholders equitably
- At early durations, not appear too low compared with premiums paid, accounting for any projected maturity values
- At later durations, be consistent with projected maturity values
- Not exceed asset shares, in aggregate, over reasonable time period
- Competitors’ surrender values (and possibly also auction values, where applicable)
- Not be subject to frequent change, unless dictated by financial conditions
- Not be subject to significant discontuities by duration
- Not excessively complicated to calculate, accounting for computing power available
- Be capable of being documented clearly
- Avoid selection against insurer
Discuss the influence of PRE when setting SVs in terms of
Discontinuance at short durations (4)
- The amount paid on surrender is normally at the discretion of the insurer. Legislation may exist to ensure that policyholders are treated fairly and that policyholders’ reasonable expectations (PRE) are met.
- There is no generally accepted definition of PRE, but they will be influenced by, for example, the past practice of a company and any literature issued by it
Discontinuance at short duration
- SVs likely compared to premiums paid (sometimes with interest), but usually ass share less than this
- prospective policy value based on best estimates of future experience likely to be even smaller
- insurers may feel obliged to accept losses/reduced profit on SVs several years into contract
- could penalise later surrenders to cope/not offer SVs at all for some initial time
Discuss the influence of PRE when setting SVs in terms of
Discontinutnace close to maturity (3)
Discontinuance close to maturity
- where maturity benefit payable, PHs will expect SV prior to maturity to be consistent with this
- SVs should progress smoothly at each year end into maturity value
- achievable for without profits contracts: base SV on prospective polcy values
Discuss the influence of PRE when setting SVs in terms of
How they compare to auction values (4)
How SV compares with auction values
- auction value is what policy obtained if PH transferred ongoing policy to someone else, dealth with by specialist brokers)
- auction values assessed independently = hence PHs may accept as fair
- often unsuitable, though
- difference in assumptions used eg optimism of future benefits of polcy
- values flactuate unpredictably => hard to determine, without actually selling policy
Discuss the influence of PRE when setting SVs in terms of
New business disclosure and other competitive considerations
- Insurers may provide prospective policyholders with illustrations of possible surrender values at various durations.
- In some countries this is a regulatory requirement. Such illustrations must then be borne in mind when eventually determining the surrender value.
- The financial press may publish tables showing the surrender values offered by different life insurance companies.
- Each company will need to decide to what extent it should be influenced by any, possibly adverse, comparisons resulting from the use of such tables.
- It is quite reasonable for a company to want to be seen to offer competitive surrender values as well as competitive maturity terms.
- More generally, it could be embarrassing for a company if any comment on surrender values in its literature conflicted with figures shown in financial press surveys or actually quoted to policyholders.
Discuss the influence of Earned Asset Share when setting SVs according to following:
What does the asset share represent in general? (1)
What implication does this have for SVs? (2)
What does using asset share for SV calcs mean in terms of profit/loss distributions (1)
How might we achiev averaginge over time when using asset share for SVs? (3)
Asset represents
- money insurer has really accumulated in respect of policy, unlike supervisory reserve (represents how much money company must hold)
Earned asset share can be used interchageably with asset share
- SVs must not exceed earned asset share in aggregate over a reasonable time period
The implication is
- asset share theoretically guides the maximum the insurer can afford to pay out, measured over a reasonable time period
- but it is not unique value which can be afforded in all cases i.e could give some policies more, some less
Basing SVs closely on asset shares implies
- distributing accrued profits/losses to PHs, because asset share containg all of accumulated profits/losses from policies to date
Averaging over time for SVs can be achieved in 2 ways:
- by period of ass share calc eg. 1 per year (practical) => averaging over year
- smothed ass share as basis for SV
- Decide time period(s) to smooth over, e.g. want to smooth individuals months’ ass share values so total impact of smoothing over 12 months is zero or smooth individual years’ asset share values so that the impact over perhaps five years is zero.
Surrender principles
Discuss changes in surrender scales over time and by duration
- For practical reasons, scales of surrender values should not change too frequently unless financial conditions would dictate this.
- Surrender value scales should not contain discontinuities by duration to maintain equity between policyholders who surrender on either side of the discontinuity.
- For example, it would be unfair if the surrender value one week after a policy anniversary was significantly higher than for the week before the anniversary (after allowing for any premium paid on the anniversary).
Surrender principles
Discuss Ease of application
- The surrender terms should not be excessively complicated to calculate, taking into account the computing power available.
- By surrender terms, we mean a simple formula, or table of applicable factors, which will allow mass production of surrender values by administrative staff, probably using some computer application.
- This is likely to require some simplification and smoothing of the “real” situation.
- This smoothing implies some cross-subsidy. The actuary must ensure that such smoothing is not overly detrimental either to policyholders or to the company
Surender principles
Discuss avoiding selection against the company and lapse and re-entry
Selection against the company
* The surrender terms should minimise the risk of policyholders selecting against the company.
* In fact the potential cost of such selection is sometimes so high that it is better not to offer discontinuance terms at all. This is typically the case with immediate annuity business.
* Another opportunity for selection against the life company may occur after a market crash, especially for single premium business.
* To prevent this, the company would need to revise terms immediately after any such movement in the markets.
Lapse and re-entry
* The company should ensure that surrender terms, when looked at in conjunction with the current premium rates for that product, do not make it advantageous for the policyholder to discontinue their policy and then take out a new policy.
* This could be thought of as a special case of selection against the company.
Consider the example of a without-profits whole life assurance for a sum assured of S, payable immediatley on death, with annual office premiums of G payable m times a year, where:
- x = policyholder age at date of issue
- I = initial expenses in excess of those occuring regulalry each year
- e = level annual expenses (incurred m times a year)
- f = normal claims expenses
- C = surrender expenses
State formulae for the retrospective reserve and the prospective reserve for the policy at policy duration t, and explain how these can be used to determine a surrender value.
Retrospective method
- Provided sufficient info + computing facilities, insurer may keep up-to-date asset share per contract to use to calc a SV
- however, rarely true for without profits contracts, so use retrospective reserve to deduce SV
- use formula/parameters chosen to produce acceptable results at duration required; starting point for basis is experience of policy.
-
Retrospective reserve
- D(x) / D(x+t) * { G*a(m)(x:t) - S*Abar1(x:t) - f*Abar1(x:t) - e*a(m)(x:t) - I } - C
- *annuity factor should have double dots for ‘in advance’
Prospective method
- For without profits contracts, this is value of future benefits/expenses, net of future premiums due, using estimates of future expected assumptions
-
Prospective reserve
- S*Abar1(x+t:) + f*Abar1(x+t) + e*a(m)(x+t) - G*a(m)(x+t) - C
- *annuity factor should have double dots for ‘in advance’
Table of surrender values by policy duration usually a blend of these 2 values, subject to minimum value of 0 (blending towards the prospective reserves at later durations).
Discuss the retrospective method of calculating surrenders in the context of how it meets the principles
- take into account policyholders’ reasonable expectations
o If the company adopts a retrospective method to calculate some or all of its specimen surrender values in product disclosure literature, then policyholders would reasonably expect it to do the same thing for its actual values. - not exceed earned asset shares, in aggregate, over a reasonable time period
o The retrospective value will represent the earned asset share at the date of surrender or an estimate thereof.
o Therefore, it would represent the maximum that the company could pay without making a loss - at early durations, not appear too low compared with premiums paid, taking into account any projections given at new business stage
o Also, at early durations it will not look too unreasonable compared with the premiums paid. The asset share will bear a close relationship to the premiums paid to date less initial expenses, so it will only look reasonable (assuming it’s positive) if policyholders find the deduction for initial expenses acceptable - at later durations, be consistent with projected maturity values
o Except by chance the surrender value will not run into the maturity value (ie as duration in-force approaches the full term, the surrender value will only by chance approach the maturity value).
o The asset share will not tend to the maturity value if the guaranteed amount at maturity is greater than the asset share - take account of surrender values offered by competitors
o Because the method does not take into account future benefits and expected future experience, it could produce surrender values that are significantly different from a realistic prospective value. The latter is likely to be the approach used to calculate auction values.
o The problem here is that if the values are very much less than auction values, the company may get a reputation for giving poor surrender values.
o Whether the method produces values that compare well with those of competitors depends on the method – and probably more importantly the basis – that they use. The - not be excessively complicated to calculate, taking into account the computing power available
o Provided the necessary information is available to build up earned asset shares or to determine suitable parameters if a formula is used, the method is not overly complex. - be capable of being documented clearly
- avoid selection against the insurer.
- Treat the continuing policyholders fairly
o It does not say anything about the profit the company would have made if the contract were not surrendered. Hence it is not easy to ensure equity either with continuing policyholders or with any shareholders
o The amount of profit made if a policy is not surrendered is the difference between the final maturity value and the final asset share. If the asset share is paid as the surrender value, no profit is made. If the asset share minus a certain amount (eg £100) is paid on surrender, a profit of that certain amount (£100) is made. However, the present value of this profit may be more or less than the present value of profit that would have been made had the contract not been surrendered.
Discuss the prospective method of calculating surrenders in the context of how it meets the principles
- take into account policyholders’ reasonable expectations
o If the company adopts a retrospective method to calculate some or all of its specimen surrender values in product disclosure literature, then policyholders would reasonably expect it to do the same thing for its actual values. - not exceed earned asset shares, in aggregate, over a reasonable time period
o There is no guarantee that the surrender values produced will not consistently exceed the earned asset share.
o For example, a realistic basis for a without-profits contract may produce very low or negative surrender values early in the term of the contract - at early durations, not appear too low compared with premiums paid, taking into account any projections given at new business stage
o The main difficulty with a prospective calculation is deciding on the appropriate rate of interest. This makes the approach difficult to apply at short durations – and hence long outstanding term – because even very small changes in the rate of interest will have a significant effect on the surrender value. - at later durations, be consistent with projected maturity values
o The surrender values will run into the maturity value for without-profits contracts - take account of surrender values offered by competitors
o The prospective method is more likely than the retrospective method to produce comparable surrender values to those available at auction and for comparable competitors’ contracts, since it is the method that is normally used. - not be excessively complicated to calculate, taking into account the computing power available
o Unless the company decides to use a complicated basis, it is relatively easy to operate since it does not require any knowledge of what has happened in the past. - be capable of being documented clearly
- avoid selection against the insurer and avoid lapse and re-entry
o There is no guarantee that the surrender values produced will not consistently exceed the earned asset share - this may lead to lapse and re-entry leading to loses - Treat the continuing policyholders fairly
o If a realistic basis is used with this method it will produce a surrender value that represents what the contract is worth to the company. In particular, in the context of without-profits contracts, it enables the company to quantify how much profit to retain and hence maintain equity with continuing policyholders and any shareholders.
o A prospective valuation of a contract calculates how much it will cost the insurance company to provide the benefits and associated expenses allowing for the future premiums that would have been paid. If the surrender value equals a realistic prospective value, then the cost of the surrender is exactly the same as the expected cost of the contract remaining in force.
List the steps that go into, and need to be broadly considered, to calculate SVs
(4)
- Choose method
- Consider profit retention implied by method used
- Determining the basis for either
- retrospective value
- prospective value
Calculate SV: Choice of method
How might we use retrospective and prospective methods for the eventual SV calculations? (1)
In early years/policy durations what do we have to pay particular attention to when calc’ing SVs? (3)
Discuss the use of retrospective method throughout policy duration for SVs (1)
In later years/policy durations what might we do for SV calcs? (4)
For eventual SVs
- produce a table of SVs by policy duration which is a blend of retrospective and prospective values, subject to min value of zero
In early years,
- pay close attention to actual expenses incurred (particularly initial expns)
- other factors are of lesser importance in short term
- retrospective values are likely to be more natural approach
Theoretically, could just use retrospective throughout policy duration for SVs
- but can become increasingly difficult to find right combo of factors to produce values which run into maturity if calc had to be done by devising some independent formula and setting parameter values for it
After earlier years
- prospective methods more convenient, since only necessary to value future benefits, premiums and expenses
- main difficulty is deciding appropriate interest rate
- thus difficult to apply at short durations and, hence, long oustanding
- …because small changes in interest rate => big effect on SV
What do we mean by ‘profit retention’ in context of SVs? (2)
What other important feature must be checked when deciding on method for SV calcs? (2)
Profit retention relates to
- excess of earned asset share over SV paid,
- the higher SV paid compared to asset share, the less profit we retain
Also important to check for lapse and re-entry risk due to chosen basis
- can be done by ensuring earned asset share is greater than surrender value
Comment on use of retrospective method for SVs in relation to retained profit (1)
Retrospective method profit retention => no profit
- wouldn’t want to use retrospective method for too long, since SV is equal as asset share
For prospective method SV calc, show how insurer profit retained on surrender can be split into (a) past profit and (b) capitalised value of future profit by considering SV calculated on the premium basis (5)
Prospective method profit retention
- depends on relationship btwn SV assumptions vs office prem assumptions
- if profit allowance contained solely in assumption margins used to calc office premium then profit retained can be specified as
- (EAS - SV’) + (SV’ - SV”), where
- EAS = earned asset share
- SV’ = prospective SV using office premium assumptions
- SV’’ = prospective SV using surrender value basis assumptions.
- (EAS - SV’) + (SV’ - SV”), where
- 1st part, (EAS - SV’), represents the profit that’s been made to date
- 2nd part, (SV’ - SV’’), represents capitalised value of profit that will arise in future.
How can the SV assumptions used impact insurer’s retained profit? ( 6 )
Prospective meth SV assumptions used can impact insurer’s retained profit
- if SV assumptions represent exactly future experience (best estimate), then total profit retained will be same as if contract had not surrendered
- if SV assumptions same as premium basis assumptions, then profit retained will equal profit made to date
- suitable choice - btwn best estimate & premium basis can adjust profit retained in line with desired aim of insurer
- possible approach uses blended basis
- start with premium basis near entry (retaining profit earned to date)
- ….and running into best estimate basis closer to maturity
- how quickly it runs into best estimate basis depends on how quickly it can start retaining same profit as form non-surrendered contract
