Ch25: Surrender values

Question 1

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 by making some profit on later lapses
• asset shares are quite volatile, so it would be difficult to devise a surrender scale that would treat policyholders fairly in relation to this
• asset shares can be negative at later durations - and or likely to be decreasing towards the end of the policy. Hard to sell the idea of decreasing surrender values

Question 2

Things to keep in mind when determining surrender values

Answer 2

Surrender values should:
1. take into account PRE
2. at early durations, not appear too low compared with premiums paid, taking into account any projections given at new business stage
3. at later duration, be consistent with projected maturity values
4. no exceed asset shares, in aggregate, over a reasonable time period
5. take account of surrender values offered by competitors
6. not be subject to frequent change, unless dictated by financial conditions
7. not be excessively complicated to calculate, taking into account the computing power available
8. be capable of being documented easily
9. avoid selection against the insurer

Question 3

Disadvantages of asset share method for without profits business

Answer 3

For without profits, no profit is retained by the insurer. Also, it could be inconsistent with the maturity value, negative early on and hard to calculate

Question 4

Methods to calculate surrender values

Answer 4

• earned asset share per policy
• retrospective reserve
• prospective reserve

Question 5

Retrospective method advantages

Answer 5

• represents the earned asset share at the date of surrender or an estimate thereof
• represents the maximum the company could pay without making a loss
• bears a close relationship to premiums paid to date less initial expenses, so it will look reasonable if policyholders find the deduction for initial expenses reasonable
• provided necessary info is provided, the method is not overly complex

Question 6

Disadvantage of retrospective method for without profit contracts

Answer 6

• doesn’t say anything about the profit the company would have made if the policy wasn’t surrendered. Hence, not easy to ensure equity with continuing policyholders or shareholders
• except by chance, the surrender value will not run into maturity value
• could produce result significantly different from prospective surrender values (which are used to calculate auction values)

Question 7

Advantages of prospective method

Answer 7

• if realistic basis is used, this method will produce value that represents what the contract is worth to the company
• surrender value will run into maturity value for without profits contracts
• more likely to produce comparable surrender values to those available at auction and for comparable competitor’s contracts
• relatively easy to operate since it doesn’t require any knowledge of what has happened in the past

Question 8

Disadvantages of prospective method

Answer 8

• no guarantee that the surrender values produced will not consistently exceed asset share
• could produce surrender values at early durations that look distinctly unreasonable from the surrendering policyholder’s point of view

Question 9

Profit retained under prospective approach

Answer 9

(EAS - SV’) + (SV’ - SV’’)

Question 10

Basis for retrospective value

Answer 10

• company will examine actual past experience for relevant factors but may use something other than past experience e.g. for profit or competitive purposes

Question 11

Basis for prospective value

Answer 11

Interest
- companies will probably cover their without profits liabilities with fixed-interest investments. Hence, company might consider the current weighted average redemption yield of suitable securities to be its best estimate assumption.
- may also consider interest rate used in premium basis if it wishes to use a blended basis

Expenses
- most recent expense investigation. Unlikely that margin will be included as this will increase surrender value

Inflation
- chosen to be consistent with investment return assumption.
- the real return on index-linked government stock will give an indication of what might be a suitable margin below the full interest rate assumption.

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

Question 12

Unit-linked surrender

Answer 12

• usually bid value of units less any surrender penalty