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Selection and surrender benefits

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asked Nov 4, 2017 in BUS 3024S - Contingencies by Rohin

BUS3024S Test 2 2005.pdf (0,1 MB) BUS3024S Test 2 2005 Memo.pdf (0,7 MB)

I have attached the 2005 test 2 papers for your convenience. My question is with respect to Q1 (b). 

I understand why surrender benefits are not given to annuitants since when policyholders feel that their future life expectancy is low, then they would surrender and receive a lumpsum benefit. If all policyholders did this, then the insurer would make unrecoverable losses. 

I don't really understand why we can offer surrender benefits to whole-life products. I know the problem with whole-life products is that the healthy lives tend to withdraw from the policy since they do not expect to make a claim anytime soon. This leaves a group of unhealthy lives which means that the insurer would be facing the possibility of making very large claims in rapid succession. 

The memo says that if surrender benefit was provided, then the individuals who would surrender are the individuals who require money immediately (and we cannot say if these lives are more/less healthy than the remaining individuals). But I don't understand what the memo is saying when it says that:

1. Selection is residual, and 

2. effect is small, and can be dealt with bonus / via profit distribution

Thanks in advance

1 Answer

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answered Nov 14, 2017 by Njabulo.Dube (2,950 points)

According to the solution, this means that they don’t know that their chances of dying are lower. ‘Residual’ in the sense that the policy is surrendered for reasons other than that the policyholder thinks they have better than average life expectancy (but not by those who ‘know’ they have a worse life expectancy).

The effect is small in that surrender pay outs are only provided on policy types that build up reserves in anticipation of future claims (e.g. not paid out on term/temporary life assurance) and the surrender value is usually substantially lower than the reserve. To the extent that the policy type provides bonuses/profit distribution, any losses due to surrenders in general, can be taken into account when deciding on the distribution (to remaining policyholders) and thus is not a loss to the office.