1. Cash Values

Policy values quantify the obligations, or liabilities, of a life insurance company.

* They are used by managers and investors to determine the financial position of the company.
* They are also used by managers and regulators to determine the likelihood that a company will continue as an ongoing operation to fulfill promises made to policyholders.

Policy values are also used to determine the allocation of investment assets needed to fulfill company obligations from issuing policies – this is the topic of Section 2. This section is devoted to the application of policy values to determine a policy’s value to the insured upon cancellation of the policy, its cash value.

An insurance policy provides a combination of protection against unforeseen risks (the insurance element) as well as a savings plan (the investment component). When a policyholder decides to terminate the contract prematurely (before called for in the plan design), in many cases the policyholder will receive an amount known as a cash value, withdrawal benefit, or nonforfeiture benefit. You can think of the cash value as the policy value minus a surrender charge, that is,
begin{eqnarray*}
_k CV = ~ _k V -~ _k SC.
end{eqnarray*}
Because of the difficulty of collecting additional funds from a withdrawing policyholder, (_k CV geq 0.)
Determining the cash value (or, equivalently the surrender charge) is not straightforward. One needs to think about fairness to the continuing policyholders as well as fairness to those that terminate the contract. One viewpoint is that those that surrender their policy have not fulfilled their contract and therefore are not entitled to any benefits. Another viewpoint is that those that surrender their policy should receive all of their premiums minus a charge for the insurance protection received.

It is also important to recognize the timing and incidence of expenses because most insurance contracts are costly to underwrite and incur substantial expenses in the early years. Later, we discuss an alternative reserving basis that acknowledges high early expenses.

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