Chapter 25

Question 1

Explain whether the supervisory reserve would be expected to be bigger than, or smaller than, the surrender value(5)

Answer 1

• The supervisory reserve assumes a prudent basis whereas the surrender value is mainly influenced by the asset share
  -thus which will be greater depends on the actual experience influencing the asset share in comparison to the expected experience assumed in the supervisory reserves
  -given its prudence, we expect the supervisory reserve to be higher
  -the answer depends on the rules applying in the country concerned
  -in many, supervisory authorities require the insurer to hold at least the total amount of surrender value in reserve to cover the possibility of mass surrender

Question 2

List the 5 reasons for having no surrender values in term assurances

Answer 2

• Low asset shares
• high cost of selective withdrawals
• The asset share is volatile due to its susceptibility to mortality
• the asset share tends to fall and even become negative at later durations
• Ensure that initial expenses are recouped

Question 3

Would it be reasonable to offer surrender values for immediate annuities? (6)

Answer 3

• Argument for offering a surrender benefit would be that due to the significant premium paid, the asset share is positive,
• A surrender charge will be required to recoup initial expenses
• However, in practice it is not advisable to have surrender benefits on immediate annuities
• Increases the risk of selective withdrawals significantly, for example, those considering themselves to have lower longevity may surrender
• This leaves the insurer exposed to longevity risk greater than that priced for
• Additionally, in the event of uncertainty such as a economic collapse or natural disaster, this may result in a “run of bank”

Question 4

List the principles to consider when determining how to calculate the surrender value (10)

Answer 4

• PRE
• ASt (should be lower over a reasonable time period)
• Capable of clear documentation
• Ease of Calculation
• Must Prevent Selection Against Insurer
• Surrender and Entry
• Surrender Value Scales Should Not Contain Discontinuities
• Surrender values should include bonuses declared to date and consider whether all or portion of terminal bonus should be granted on surrender.
• New Business Disclosure
• Competition
• Policyholder Comparisons at early durations and close to maturity
• The basis should not be subject to frequent change, unless dictated by financial conditions

Question 5

What is an auction value in life insurance, and how does it differ from the surrender value? (7)

Answer 5

• the price a policy could fetch if sold to another person on the second-hand market, rather than being surrendered to the insurer
  *It reflects the independent market value of the policy.
  
  • Advantages:
• Provides an independent and potentially fairer measure of the policy’s worth.
• May result in a higher payout for the policyholder than the insurer’s surrender value.
  
  • Disadvantages:
• Assumptions may differ from the insurer’s, often being too optimistic.
• The value can fluctuate and is hard to determine without an actual sale.
• Not practical for insurers to use as a basis for surrender values.

Question 6

Describe the retrospective method of calculating surrender values including advantages and disadvantages (9)

Answer 6

• Looks backward — based on past experience of the policy.
  
  • Calculates surrender value from accumulated premiums + investment returns − expenses − mortality costs − surrender cost (C).
  • Represents the earned asset share — the maximum the insurer can pay without loss.
  • Used mainly in early policy years.
  • Advantages:
  • Reflects actual experience (premiums, expenses, investment).
  • Simple if detailed policy data are available.
  • Disadvantages:
  • Ignores future profits or obligations.
  • May not run smoothly into the maturity value.
  • Can create inequities between surrendering and continuing policyholders.

Question 7

Describe the prospective method of calculating surrender values including advantages and disadvantages (9)

Answer 7

• Looks forward — based on future expected experience.
  
  • Calculates surrender value as PV(future benefits + expenses) − PV(future premiums) − surrender cost (C).
  • Represents what the policy is currently worth to the insurer.
  • Used mainly in later policy years.
  • Advantages:
  • Surrender values merge smoothly with maturity values.
  • Allows control over profit retention and fairness among policyholders.
  • Consistent with market (auction) and competitor methods.
  • Disadvantages:
  • Can give very low or negative values early on.
  • Highly sensitive to assumptions, especially interest rate.

Question 8

How does profit retention work when calculating surrender values?

Answer 8

Prospective method:
Retained profits = (EAS-SV) + (SV - SV``)
=earned profit to date + capitalised value of profit that will arise in future resulting from the difference in the premium basis and the surrender value basis

• if SV basis = actual future experience => it’ll be as if the policy was never surrendered
• if SV basis = premium basis => retained profit=earned profit
• we can start with the premium basis to ensure that the insurer doesnt pay benefits that are too high at early durations
• then switch to the SV basis = BE to pay a larger benefit
• the time of the switch depends on how quickly we feel we can start retaining the same profit from a non-surrendered benefit
• we just need to ensure there is no lapse+entry by checking that ASt is not <SV

Retrospective:
Retained profits = 0

Question 9

Describe how to choose the retrospective SV basis

Answer 9

• Consider past experience (investment returns, mortality, expenses, etc.)
• But dont match past exactly
• Smooth experience especially for investment returns to smooth out those short-term asset return volatilities
• investment returns could also be made lower to increase retained profits
• expenses could be made lower if EAS is extremely small

Question 10

Describe how to choose the prospective SV basis

Answer 10

Interest
* Most important assumption
* May match without-profits L with fixed interest investments
* So BE assumption may be a weighted average redemption yield
on suitable securities
* OR use the interest rate used in the premium basis

Expenses
* May use its most recent expense investigation to indicate level of renewal
expenses
* This may be the same as that used in the premium basis
* Unlikely that margins will be added as this will increase the surrender value o Allowance needs to be made for renewal commission and for the surrender
charge

Inflation
o Must be consistent with the investment return assumption
o May look at the real return on an inflation linked government stock

Mortality
o Mortality basis chosen must reflect the expected future mortality of those
surrendering= for life cover, they SHOULD be healthier than most=> lower than normal mortality
o Select mortality tables may be used or use up to date experience and rely on other margins in basis
o For most, assurance contracts with surrender options, mortality assumption is not that significant

Question 11

How are surrender values determined for unit-linked contracts

Answer 11

 The surrender terms and alterations will be specified at outset
 Surrender value is typically the bid value of units less surrender penalty
 Surrender penalty being a percentage of premium or percentage of unit value
 May be larger at early policy durations
* no penalty where there are high initial charges
* monetary penalty where there are reduced level allocation rates for several years