Simple Life Insurance Question

[Anonymous]

Please excuse what's probably a stupid question from a pension practitioner.

In the last paragraph on page 229 of the Life Insurance text, it says, "For example, for a single-pay non-par whole life product, the company may want to examine the effect of a slow decline in interest rates, couple with slowly increasing LAPSE and mortality rates, over a period of many years."

My question is - Can a single-pay whole life policy LAPSE? Did they mean surrender rates?

Thanks.

[Old Man]

I'm sure they meant surrender. I haven't re-read this text yet, but recollection is that the text is not consistent in how it defines lapse and persistency. At some points, persistency means lapse only. At others, it means lapse and mortality.

[Possum 2]

Since the policy has a cash value, it could lapse and the insured would receive the cash value as of the time of lapse. It does sound sort of strange to use "lapse" in such a context - perhaps "redeem the cash value" or something along similar lines would be clearer.

[LightSwitch]

I have not read this text this time around yet, but there is a distinction between lapse and surrender. Surrender is at the initiative of the policyholder and the policyholder receives the remaining cash surrender value. Lapses occur when the cash accumulation value, net of policy loans, basically runs out or when scheduled premiums are not paid. In the case when schedule premiums are not paid, the cash surrender value is submitted to the policyholder. (In the case of the single premium whole life, all premiums are paid up front.) For an interest sensitive plan -- which I think we are discussing here -- I think lapses can occur when credited interest rates are too low. (I know that there is a minimum guaranteed rate of interest so I am actually not sure if this minimum guaranteed interest rate should guarantee that the policy stays in force.) Also note that as mortality (cost of insurance) charges increase with age, larger amounts get deducted from the cash value account. The effects of mortality, low credited interest rates and policy loans can cause the policy to lapse, I think.

Excellent question, by the way. I think that especially for those who got this far in the SoA exam process, any question is a good question.

[urysohn]

Couple of comments...
1. A single pay interest-sensitive product can lapse on its own. Usually this would not occur under currently illustrated assumptions, but with maximum mortality and expense charges and minimum interest credited, some (most) product designs will fail to mature.
2. Technically, you could say that lapses occur by contract design (fund runs out due to insufficient premiums) and surrenders are caused by policyholders actively terminating the policy. Even in day-to-day life insurance conversation, that's not universal. "Surrenders" and "lapses" are terms that are used interchangeably to discuss a policy going from an active to a terminated state. (Lapses are also sometimes used to describe a surrender if the policy had not developed any cash value yet)
3. When modelling life insurance plans, you have a set of assumed "lapse rates". These represent policyholder surrenders since the projection software would naturally terminate policies which were too lowly funded. So, from a pricing actuary's perspective they are all just "lapses".

[Steve Grondin]

Based on the context (Scenario Testing is the title of the section), I think they are thinking of lapse as elective termination rather than lapse due to lack of value. Presuming that it is a "dynamic" product, I say this because a lapse due to lack of value would not be a driving assumption but rather a result of the interest rate environment and crediting strategy, policy loan utilization (for products with a loan/non-loan crediting differential), mortality and expense charge levels, etc.

[LightSwitch]

But as interest rates go down would not (1) elective lapses/surrenders decrease and (2) lapses (non-elective) increase? Thus they seem to be discussing non-elective lapses.

By the way, anyone have trouble with the apostrophe? Apostrophe: ‘

[urysohn]

A decline in credited interest rate should be accompanied by increased lapses if the assumed competitor's crediting rate (or general market interest rates) remain steady or do not decrease as much as the crediting rate. This is equivalent to lapses increasing when the market rate shoots up and you don't raise your crediting rate quickly enough to keep up.

But in this particular case, it sounds like they're illustrating the idea of "bad case scenario" (not worst-case neccesarily) Based on the context I'd guess they're referring to the Earned Rate when they're talking "interest rates", not the crediting rate. Earned Rate would be the amount your Investments department can earn on the assets backing the policy liabilities. In most models, the Credited Interest Rate would be either constant or it would be a function of the Earned Rate. So they're having the earned rate go down, lapses go up, and mortality go up. All three of those are things you would prefer not to happen to your policy.
(And incidentally, it is quite common to do sensitivity tests on your profit results and have conditions of: mortality +/- 10%, lapses +/- 10%, and earned rate +/- 50 basis points. And as one last sensitivity test, do all three at once -- exactly what he is describing)

[LightSwitch]

A decline in credited interest rate should be accompanied by increased lapses if the assumed competitor's crediting rate (or general market interest rates) remain steady or do not decrease as much as the crediting rate. This is equivalent to lapses increasing when the market rate shoots up and you don't raise your crediting rate quickly enough to keep up.



Key word: sensitivity.

There are two conditions here in terms of affect on lapses: (1) decline in interest rates and (2) your competitor having a higher crediting interest rate.

Question: How sensitive are lapses to the difference between your crediting interest rate and that of your competitor?
Answer: Significantly sensitive. The increase in lapses that is caused by crediting a lower interest rate than your competitor occurs no matter what direction the interest rates are moving.

Question: What is the sensitivity of lapses to the decline in interest rates?
Answer: Lapses decrease as interest rates decline because of the minimum guaranteed interest rate. (This occurs unless you always assume that your company will always credit a lower interest rate than your competitor in a decreasing interest rate scenario; I do not see why you would assume this.)

Now if you consider simultaneously the two causes (decrease in interest rate and competitor"s crediting interest rate and the affect that each has on each other) then it really depends.