Lesson 5: Calculation C – Other Benefits
Apart from paying benefits on specified events (death / TPD / CI), some insurance products also pay benefits on other conditions, such as surrender and maturity:
- Surrender benefits – Payable upon surrender (i.e. voluntary withdrawal), which the amount is also known as “cash value”. Surrender benefits are payable from risk funds (e.g. participating products, single premium credit products) or account balances (e.g. universal life products, investment-lined products). Many non-participating regular premium products, such as term products, do not pay any surrender benefits or pay only minimal amount upon surrender (and hence the policyholders pay lower premiums).
- Maturity benefits – Payable upon maturity, especially endowment. Maturity benefits are payable from risk funds (e.g. endowment) or account balances (universal life products, investment-linked products). Term, medical, personal accident and general insurance products normally do not pay maturity benefits.
Understand calculations required for surrender benefits and maturity benefits and identify inputs required for the calculations. Update your cash flow models.
Calculate Surrender Outgo
Surrender benefits in a cash flow model can be calculated using one of the following approaches:
- Read values from surrender value tables – The policy administration system implemented by an insurance company may use table approach in calculating surrender value. However, such approach may require a very large surrender value table, in order to cater for different entry ages and policy terms.
- Calculate from surrender cash flow – Use a separate cash flow to calculate surrender value, i.e. APV(Future Benefit) – APV(Net Premium). The assumptions and formulas used to calculate surrender value need to be consistent to what have been used in product pricing (i.e. which may be different from the projection assumptions). The surrender cash flows are normally simpler than the projection cash flows, e.g. do not consider commissions and expenses.
When calculating per policy surrender value, calculated APV or values read from the surrender value table may be subject to “surrender charge” (reduce surrender benefit by a certain %), which may vary by policy year. One of the purposes of imposing surrender charge is to discourage policyholders from surrendering policies, especially during early policy years (which the insurance / takaful company may encounter losses due to high acquisition costs).
Example: A 10-year term policy (covers death only) with level sum assured = 10,000 use annual cash flows to calculate surrender value (using formula shown below). Surrender value calculations are subject to the following assumptions:
- Death rate for Year 1 is 0.001 and increase by 0.001 annually. Assume no lapse.
- Annual investment yield is 5.00%.
- Surrender charge is only applicable for first 3 policy years, i.e. 75% (Year 1), 50% (Year 2) and 25% (Year 3).
If the policy is surrendered in Year 5, the policyholder will get 120.82 (apply rounding if necessary). If no. of surrender under a seriatim Model Point projection is 0.50, surrender outgo is calculated as 126.17 × 0.50 = 60.41.
