Chapter 26 Flashcards
(31 cards)
How does a paid-up contract work?
The PH stops paying premiums, but there is still some eventual benefit. In effect the value of the policy is used as a single premium to purchase an insurance policy at the date on which the original premium payments cease.
Why are the bases used for the calculation of paid-up value and SV different?
- The costs of making the policy paid-up are different from those of paying a SV.
- PH continues to have a policy in force - the effect of mortality selection may be less than when policies are surrendered.
What would change under a without-profits contract if the policy becomes paid-up?
The terms and conditions of the original policy remain unchanged, except the SA is reduced to reflect the fact that no more premiums will be paid.
Why do alterations typically occur?
Most life insurance contracts are LT contracts - over time, a mismatch may occur between the cover provided and the current risks faced by the PH. To remove this mismatch, PHs purchase additional policies or alter current policies.
What are examples of general alterations?
- Changes to the term of the policy - a term changed to 0 = surrendering policy
- Changes to premium payable
- Changes to the SA
– reduction in the SA so that no future premiums required = paid-up policy
– increase in the SA - keeping the original policy and purchasing an incremental policy at current rates
With what should alteration terms be consistent?
- SVs
- Paid-up values
- Current terms offered for new policies
What principles should be considered when determining how to calculate the paid-up sums assured?
- SVs - paid-up sums assured should be consistent with SVs so that SVs before and after conversion are approximately equal (ensure fairness and avoid selection)
- Projected maturity values - paid-up sums assured should, at later durations, be consistent with projected maturity values, allowing for premiums not received
- Asset shares - paid-up sums assured should be supported by the AS at the date of conversion on the basis of expected future experience
- The company’s expected profit from a paid-up policy should be consistent with (not necessarily equal to) that expected from a non-paid-up contract
What is the key principle for alteration of without-profit business?
- The terms after the alteration should be supportable by the AS at the date of the alteration to avoid the company making a loss.
- I.e. the altered policy should not need more than the future premiums after the alteration plus the current AS to meet the benefits and expenses of the post alteration policy.
- Ideally the expected profit from a contract after alteration should be the same as before, or alternatively, the same as expected amount had the contract originally been written on its altered terms.
What are boundary conditions?
Boundary conditions refer to a set of rules that determine:
* Whether the alteration is within the scope of the original contract or creates a new contract
* How the future CFs should be handled post alteration
* Whether an insurer can adjust pricing, reserves or assumptions due to change
These conditions help determine whether an insurer can reassess risks and reprice the policy after alteration, or if they must continue under original assumptions.
What are a few things to consider for altered policies with regards to boundary conditions?
- Change from one policy, with little value, to another policy - treat as new policy
- Premium significantly reduced - treat as a paid-up policy
- SA significantly increased - treat as new policy
- LT of policy left and reduced to a very ST - treat as a surrendered policy
- Term of a LT contract, with plenty of term left, reduced by 2 years - treat as alteration to itself
When assessing an alteration method, against which principles can we judge it?
CAFES
- C - Consistency with boundary conditions
– Surrender – limiting case of reduction in term. Company will wish that, as outstanding term tends to 0, premiums charged look consistent with difference between SV + maturity value
– Paid-up – limiting case of reduction in sum assured. Apart from any expenses to be incurred, premium after alteration should approach 0 as SA approaches paid-up SA
– New policy – increased benefits should be consistent with additional premium charged for new policy
– Term to be extended - Ts and Cs should reflect the current premium basis so far as the period of extension concerned - A - Affordability and avoidance of lapse and re-entry: the cost associated with carrying out an alteration should be considered
- F - Fairness: Increase in the benefit may be subject to additional evidence of health, depending in part on the scale of alteration and when it occurs in policy’s lifetime
- E - Ease of calculation, application and explanation
- S - Stability (e.g. small changes in benefits should result in small changes in premiums): the alteration terms should ideally produce the existing terms if the policy is altered to itself
When setting alteration terms, what is very very important to remember?
We need to take care against:
* Mortality selection - e.g. extending the term of an EA
* Financial selection
How does the proportionate paid-up values method work?
It is an approximate method that simplifies the calculation of paid-up values.
paid-up value = SA*(# premiums paid/#total number of premiums payable)
Rarely used nowadays since its simplicity is of reduced value with the computing power available.
What are the advantages of the proportionate paid-up method?
- It is simple to apply
- Easy to explain
- It requires no assumptions
What are the disadvantages of the proportionate paid-up method?
- Values are usually too high at short durations, because they do not allow for the high initial expenses
- At medium durations they tend to be too low because no allowance is made for investment earnings
- Early premiums buy larger proportion of SA, because of time to maturity + effect of compound interest – means that at most durations, proportionate value understates true value of policy, although it will tend to maturity value as duration of making policy paid-up approaches maturity date. Early on, initial expenses dominate, causing true paid-up SA to be negative
- Unlikely to be consistent with SVs
What is the equating policy values method used for alterations?
The value of the contract before the alteration, on a prospective or retrospective basis, can be equated to a prospective value after alteration that considers the requested changes to terms of the contract.
How are the altered terms calculated using the equating policy values method?
- Equating policy values:
* Start with an equation: (old policy value) = (new policy value) + (alteration expenses) - Prospective or retrospective reserve:
* If the method is not stated, or at least reasonably implied by the information given, then it would be usual for a prospective value to be required. - Renewal expense assumption:
* Unless otherwise stated, expenses expressed as a percentage of premium will relate to the premium that applies to the reserve calculation (new or old) concerned. - Ultimate or select mortality:
* Again, unless otherwise stated, any policy value calculated at time t years through an existing policy will be calculated assuming select mortality ([𝑥] + 𝑡).
* Where AM92 mortality is assumed, reserves calculated for 𝑡 ≥ 2 will be calculated using ultimate mortality. - Remember: “immediately before the start of the nth year” → at time n – 1.
Do we charge for future renewal commission on paid-up policies?
NO.
Write the equating policy values in an equation form.
old policy value = new policy value + cost of the alteration
reserve held at time t for old policy = reserve held at time t for new policy + cost of the alteration
old policy value + value of future new premiums under altered policy = value of future benefits + value of future expense + the cost of alteration
We want to find a value of either:
* S for a given value of P
* P for a given value of S
What are the advantages of the equating policy values method?
- The method will produce consistent SVs immediately before and after the alteration - if the same methods and assumptions are used for calculating SVs
- For an extension of term or increase in benefit, use of current premium basis to calculate the before and after alteration policy values would ensure consistency with the terms of new contracts
- If the same bases are used, there will be consistency between
▪ Terms for alterations,
▪ SVs
▪ Conversions to paid-up status - Assuming the same basis is used for the before and after policy values, the method is stable
- Alteration terms should be affordable, provided that
▪ The policy value before alteration is not greater than the earned AS and
▪ The basis for policy value after alteration is not weaker than a best estimate basis
What are the disadvantages of the equating policy values method?
- It will not necessarily avoid lapse and re-entry
- Company would need to check that the premium being charged after alteration is not more than it would charge for a completely new contract
On what does the total profit expected from an altered policy depend?
On the relationship between:
* Method and basis used for calculating policy values before the alteration, which determines the profit released at the time of the alteration
* Method and basis used for calculating policy values after the alteration, which determines the profit expected to emerge over the remaining term of the contract
How will the profit at the alteration date vary?
- Full expected profit to date under the unaltered policy - realistic prospective valuation basis used for the policy valuation before the alteration
- No profit - AS used for policy value before alteration
- Something in between - realistic prospective valuation basis incorporating margins used for policy value before alteration
How will the profit expected to emerge from the date of the alteration, over the remaining life of the contract vary?
- No profit - realistic prospective basis used for policy value after alteration
- Profit corresponding to margins in assumptions - realistic prospective valuation basis plus margins used for policy value after the alteration
