Chapter 26 - Alterations

Question 1

What are the alterations available on a conventional without-profits contract

Answer 1

• making the policy go PAID-UP
• Change the TERM of an assurance
• Alter the SUM assured
• Alter the PREMIUM payable

Question 2

What are the two considerations that might make the bases used for the calculation of paid-up values slightly different from the bases used for surrender values

Answer 2

• The COSTS of making a policy paid-up may be different from those of paying a surrender value
• Because the policyholder continues to have a policy in force, the effect of MORTALITY SELECTION may be less than when policies are surrendered

Question 3

What principles should be considered when determining how to calculate paid-up sums assured

Answer 3

• Be supported by the EARNED asset share at the date of conversion on the basis of expected future experience
• At later durations, be consistent with projected MATURITY values, allowing for premiums not received
• Be consistent with SURRENDER values, so that the surrender values before and after conversion are approximately equal

Question 4

What should the profit expected after alteration be

Answer 4

It should be the same as that before, or alternatively, the same as the expected amount had the policy been written originally on its altered terms

Question 5

Boundary condition on surrender value

Answer 5

Surrender can be viewed as the limiting case of a reduction in policy term.

So as the outstanding term tends to zero, the premiums charged look consistent with the difference between the surrender value and the maturity value

Question 6

Boundary case on paid-up status

Answer 6

A conversion to paid-up status can be viewed as the limiting case of a reduction in sum assured.

Hence, the premium after alteration should approach zero as the sum assured approaches the paid-up sum assured

Question 7

Boundary case on benefits to be increased

Answer 7

This should be consistent with the additional premium which would be charged for a new policy with a sum assured equal to the proposed increase

Question 8

In assessing an alteration method, the principles we judge it against include:

Answer 8

MAP CAFES

• MANAGES anti-selection risk
• AFFORDABILITY
• POLICYHOLDER reasonable expectations
• CONSISTENCY with boundary conditions, eg surrender, paid-up, new policy
• AVOIDANCE of lapse and re-entry
• FAIRNESS between shareholders and policyholders and reasonable amount of profit
• EASE of calculation and of explanation to the policyholder
• STABILITY

Question 9

What is the method of calculating the proportionate paid-up values for without-profits endowment

Answer 9

The paid-up value may be calculated as the basic sum assured multiplied by the ratio of the total number of premiums actually paid to those originally payable throughout the total term

Question 10

At what duration would you expect it to be possible to offer a paid-up value for the policy without suffering a loss compared to when a surrender value is offered

Answer 10

Later than when the surrender value is offered. This is because with a paid-up policy, renewal expenses continue (unlike with a surrender). This means that a policy will not support a paid-up value until some time after it supports a surrender value

Question 11

Advantages and Limitations of proportionate paid up value

Answer 11

Simple to calculate
Easy to explain to policyholders

Too high at short durations: ignores high initial expenses
Too low at medium durations: no allowance for investment earnings
Not consistent with surrender values

Question 12

What are the methods of calculating alteration vlaues

Answer 12

• Proportionate paid-up values
• Equating policy values

Question 13

What is the method of equating policy values to calculate alteration values

Answer 13

The value of the contract before alteration, on a prospective or retrospective basis, can be equated to a prospective value after alteration that takes into account the requested changes to the terms of the contract plus the cost of alteration

Question 14

Formula for calculating terms for an alteration

Answer 14

old policy value + value of new premiums = value of new benefits + value of new expenses + alteration expense

Question 15

What are the principles behind equating policy values

Answer 15

SNAILS

1. Consistency with SURRENDER Values
   The method produces consistent surrender values immediately before and after alteration, if the same assumptions and methods are used.
2. Consistency with NEW Business Terms
   For alterations like term extensions or benefit increases, using the current premium basis ensures consistency with terms offered for new contracts.
3. AFFORDABILITY
   As long as:
   The policy value before alteration is not greater than the earned asset share, and
   The post-alteration basis is not weaker than a best estimate basis,
   Then the alteration terms are affordable and sustainable.
4. INTERNAL Consistency Across Alterations
   The method ensures consistency between alteration terms, surrender values, and paid-up values, provided the same basis is used throughout.
5. Avoid LAPSE and Re-entry
   The terms should not incentivise policyholders to lapse and take out a new policy for better terms
6. STABILITY
   If the same basis is used before and after alteration, the method is stable.
   Small changes in policy terms lead to small, predictable changes in premiums or benefits.

Question 16

Determining the basis for equating policy values method

Answer 16

Assumptions Required:

• Investment return
• Mortality (Select vs Ultimate depends on underwriting requirements)
• Expenses (including alteration expenses)

These assumptions should reflect those implicit in pricing a new contract at the alteration date.

Question 17

The total profit expected from an altered contract using equating policy values depends on the relationship between?

Answer 17

• The method and basis for calculating the policy value before alteration, which determines the profit ‘released’ at the time of alteration
• The method and basis for calculating the policy value after alteration, which determines the profit that is expected to emerge over the remaining term of the contract

Question 18

The profit ‘released’ at the date of alteration using the equating policy values will be

Answer 18

• Realistic prospective value before alteration → Full expected profit is released immediately.
• Earned asset share before alteration → No profit is released.
• Prospective value with margins → Partial profit is released.

Question 19

The profit expected to emerge, from the date of alteration, over the remaining life of the altered contract will be

Answer 19

• No profit at all, if a realistic prospective value is used for the policy value after alteration
• Profit corresponding to the margins in the assumptions, if a prospective value using a basis incorporating margins is used for the policy value after alteration

Question 20

Assumptions for Equating policy values

Answer 20

The assumptions used will be implicit in the pricing of a new contract issued at the date of alteration to provide the benefits before the alteration and the benefits after the alteration