Chapter 25 - Surrender Values

Question 1

5 reasons to not offer surrender values under term assurance policies:

Answer 1

1. Low asset share
2. Cost of selective withdrawal
3. To recoup losses on early lapses (when asset share is negative) by making some profit on later lapses (when asset share is positive)
4. Asset share is quite volatile, so it would be difficult to devise a surrender value scale that would treat PH fairly in relation to this
5. Asset shares can be negative at later durations - and/or are likely to be decreasing towards the end of the policy. Would be hard to sell the idea of decreasing surrender values to PH

Question 2

In determining how to calculate surrender values, the following principles should be considered: (9)

Answer 2

Surrender values should:
1. Take account of 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 durations, be consistent with projected maturity values
4. Not exceed earned 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 clearly
9. Avoid selection against the insurer
10. Be fair to leaver and continuing PHs

P RE
A sset share
L ater durations - maturity values
A void discontinuities
C ontinuing policyholders
E arly durations - premiums paid

D ocument clearly
I nfrequent changes
C ompetition
E ase of calculation

Question 3

What is the auction value of a policy?

Answer 3

The value ot would fetch if the PH were to transfer it as an ongoing policy to someone else. Such transactions are usually dealt with by specialised brokers

Question 4

Disadvantages of using the retrospective valuation method for without profits contracts to determine the surrender value: (5)

Answer 4

1. Does not say anything about the profit the company would have made if the contract were surrendered. Hence, it is not easy to ensure equity either with continuing policyholders or with any shareholders
2. Except by chance the surrender value will not run into the maturity value
3. No profit retained by insurer
4. Negative early on
5. Hard to calculate

Question 5

Considerations when calculating the surrender value for a unit linked policy:

Answer 5

1. Contract design and pattern of expenses incurred on the contracts will be the main factors determining:
   - whether or not a surrender penalty is needed
   - to what extent a surrender penalty depends on term and duration in force
   - the form it takes (cash or unit related)
2. SV will usually be the value of the unit fund less a surrender penalty
   - SV not likely to be guaranteed, their method of calculation is likely to be specified up front
3. Surrender penalty should be such that initial expenses (at least) are recouped
4. If initial expenses are recouped through:
   - front end load, surrender penalty may not be required
   - reduced level allocation to units, then a non-unit surrender penalty is required
   - units with high management charge, surrender penalty should be unit-related
5. If the company wants to employ actuarial funding, then unit related surrender penalty is required
6. Surrender penalties will usually vary by contract term and duration in force, and will reduce as policies approach maturity