Ch 25: Surrender values

Question 1

Factors to consider when determining without-profits surrender values are: (14)

Answer 1

• Policyholders’ reasonable expectations
• at early durations, premiums paid and illustrations given to PHs at inception (likely to accept a loss as asset share likely to be negative or very small, penalise later surrenders to recoup loss)
• at later durations, projected maturity values (should progress smoothly into maturity value, use prospective policy values in derivaton)
• not exceed asset shares in aggregate over a reasonable time period
• Make an appropriate contribution to profit if possible
• Take account of surrender values offered by competitors
• Not be subject to frequent change, unless dictated by financial conditions
• Should be no discontinuities over the duration of the policy
• Not be excessively complicated to calculate, taking into account the computing power available
• Be capable of being documented clearly
• Avoid selection against the insurer (including surrender and re-entry) also after market crash, need to recalc
• Take account of auction values that may be available
• Comply with regulatory and professional standrads
• Appropriately allow for the cost of administering the surrender

Question 2

Auction values def, advantage and disadvantages (1 & 2)

In context of surrender values

Answer 2

• The value the policyholder would fetch if they would transfer the ongoing policy to someone else.
• Usually dealt with by specialised brokers
• If the PH is dissatisfied with the surrender value quoted they can always attempt to obtain higher value on secondary market.

Advantages:
* Independent assessment and perhaps more likely to be accepted as fair by the PH

Disadvantages:
* Underlying assumptions for auction values unlikely to be the same as company’s underlying assumptions
* The value may fluctuate unpredictably and may be difficult to determine without actually putting the policy up for sale

Question 3

Asset shares in context of a consideration for surrender value calcs

Answer 3

• Represents the actually accumulated money.
• Not necessarily the only value the company could afford, may give a little more or less. However should represent the max the company can afford to payout over a reasonable period of time.
• Basing the surrender value on asset share implies distributing accrued profits (or losses) to the policyholder. (contains all of the accumulated profit to date)
• Averaging asset shares over time achievable in two ways:
  * First asset shares could be calculated once per year (practical and implicitly averages over the year)
  * Use smoothed asset share as basis for surrender values (then have to choose over which period to smooth)

Question 4

Methods of calculation (surrender values)

Answer 4

• Retrospection method
  * May have earned asset share on hand for each policy (if computing power is available) otherwise will calculate a retrospective reserve using formula and parameter values chosen to produce acceptable results at durations required
  * Assumptions based on experience of the policy and allowance made for cost of surrender
• Prospective method
  * Value of future benefits and expenses, net of future premiums due using estimates of future expected assumptions (including mortality assumption for surrendering PHs)
• See page 757 for formulas

Question 5

Advantages and disadvantages of using retrospective method for surrender value calc (4 & 4)

Answer 5

Advantages:
* Represents asset share at date of surrender and thus would represent the maximum that could be paid without making a loss
* At early durations, will not look too unreasonable compared with premiums paid (if PH find deduction for initial expenses acceptable)
* Provided necessary info is available to determine suitable parameters, method is not overly complex
* If same method is used to calculate specimen surrender values for dislcosure lirerature to PHs then they would reasonably expect it to be the same for actual values.

For without-profts disadvantages include:
* Does not say anything about the profit missed out on, hence not easy ensuring equity with continuing PHs or shareholders.
* Will be different to auction values which will probably be based on realistic prospective methods
* Will not run into maturity value (unless by chance)
* Whether it is competitive will depend on basis and method that they use.

Question 6

Advantages and disadvantages of using prospective method for surrender value calc (5 & 1)

Answer 6

Advantages:
* If realistic basis is used it will produce a surrender value that represents what the contract is worth to the company
* It enables (for without-profits) to quantify how much profit to retain and hence maintain equity with continuing PHs and shareholders
* Surrender values will run into maturity value for without-profits
* More likely to be comparable to auction values and competitors’ values since it is what is normally used (assumptions used still important factor)
* Unless a complicated basis is used, relatively easy to operate as it does not require knowledge of what has happened in the past.

Disadvantages
* Depending on basis used (realistic), values may look unreasonable from PH point of view at early durations

Question 7

Choice of method

Surrender value calcs

Answer 7

• A table of surrender values would usually be a blend of retro and prospective
• Retro more natural approach in early durations
• Prospective more convenient in later years (difficult to choose interest rate, hence better when close to maturity)
• Profit retained will be asset share - surrender value (easy to calc for retro, for prospective depends on relationship between assumptions used for surrender value and premium calc)

Question 8

Profit retained under prospective method:

Answer 8

• If assumptions represent exactly what future experience is, then profit retained will be the same as if the contract never surrendered
• If same as premium basis, then company only retains profit made to date.
• Can thus adjust profit retained as something between best estimate of future xp and premium basis.
• One approach is to use blended basis closer to premium basis near entry and runs into best estimate near maturity

Question 9

Surrender value for unit linked products

Check ch 4, ch 17 and 23 for more info

Answer 9

• Normally specified at outset
• Surrender value is normally the bid value of the units less surrender penalty applied
• Penalty may be based on % of unit value or % of premium but will be designed to recoup initial expenses.