Chapter 25 - Surrender values

Question 1

What are the main reasons for having no surrender value under term assurances

Answer 1

• Low asset share
• Cost of selective withdrawals
• To recoup losses on early lapses ( when the asset share is negative) by making some profit on later lapses ( when the asset share is usually positive)
• Asset shares are quite volatile, so it would be difficult to devise a surrender value scale that would treat policyholders fairly in relation to this
• Asset shares can be negative at later durations which would be hard to sell the idea of decreasing surrender values to policyholders, who may become disgruntled as a result

Question 2

To determine surrender values, what principles should be considered

Answer 2

FARAD’S CANCER PP

• Fairness (key principle) – surrendering policyholders, remaining policyholders and insurer (shareholders)
• Affordability
  – Negative asset shares at early durations meant that cross subsidy is required between surrenders at early and later durations in order to ensure affordability
• Regulation
• Asset share (cost recovery) – represents the maximum the company can afford to pay (on average over reasonable period of time)
• Documented clearly => send letter to policyholder stating payment and end of contract
• Stability: do not change surrender value scales too often. Ensure smooth progression of surrender values over duration.
• Competitors’ surrender values (not be too far out of line)
• Selection against insurer (avoid) (antiselection)
• New business comparison (compare surrender values to those offered on new business)
• Ease of calculation => need simple calculation formula
• Ease of explanation to policyholders
• Surrender and re-entry (avoid)
• PRE
  – Early durations: not too low compared with premiums paid
  – Later durations: consistent with projected maturity values (including expected terminal bonus)
• Professional guidance

Question 3

What is the auction value of a policy

Answer 3

It is the value it would fetch if the policyholder were to transfer it as an ongoing policy to someone else

Question 4

What is one of the starting points to consider what surrender value to offer

Answer 4

The asset share of the policy

Question 5

What are the two methods of calculation of surrender values

Answer 5

• The retrospective method
• The prospective method

Please see page 9 for formulae

Question 6

What are the disadvantages of this asset share method of determining surrender values for without-profit business

Answer 6

• It does not say anything about the profit the company would have made if the contract were not surrendered
• It could be inconsistent with the maturity value, negative early on and hard to calculate

Question 7

What does the retrospective method represent

Answer 7

It will represent the earned asset share at the date of surrender or an estimate thereof.

It would represent the maximum that the company could pay without making a loss

Question 8

What does the prospective method represent

Answer 8

It will produce a surrender value that represents what the contract is worth to the company

Question 9

Which choice of method would a company prefer to use to calculate surrender values

Answer 9

In the early years, the retrospective method is easier to use as the company will need to pay attention to the actual expenses incurred, other factors are of less importance

After the early years, the prospective method is more convenient since it is only necessary to value the future benefits, premiums and expenses

Question 10

How can the profit retained be specified

Answer 10

(EAS -SV’) +(SV’ - SV”)

EAS - earned asset share
SV’ - prospective surrender value using same assumptions as used to calculate the office premium
SV” - Prospective surrender value using surrender value assumptions

The first part of the formula represents the profit made to date
The second part represents the capitalised value of the profit that will arise in future from the differences between the premium rate assumptions and the surrender value assumptions

Question 11

Determining a basis for retrospective value

Answer 11

The company will need to examine its actual past experience for all the relevant factors, which will include investment earnings, expenses, mortality and (possibly) tax

Question 12

Determining a basis for prospective value

Answer 12

Assumptions will be needed for interest, expenses, expense inflation and mortality.

Maybe tax as well

Question 13

How will the interest assumption for the prospective basis be assumed

Answer 13

The company might consider the current weighted average redemption yield of suitable securities to be its best estimate assumption.

It may also consider the interest rate used in the premium basis if it wished to use a blended approach

Question 14

How will the expenses assumption for the prospective basis be assumed

Answer 14

the company’s most recent expense investigation will indicate the level of renewal expenses, which may well be the same as those used to set current premium rates

Question 15

How will the inflation assumption for the prospective basis be assumed

Answer 15

The inflation rate will probably be chosen to be consistent with the investment return assumption

Question 16

How will the mortality assumption for the prospective basis be assumed

Answer 16

the mortality basis should reflect the future expected mortality of those policyholders who are surrendering

Question 17

What is the surrender value for unit-linked contracts

Answer 17

It is usually the bid value of the units less any surrender penalty which applies