F O R I N T E R N A L U S E O N L Y

F O R I N T E R N A L U S E O N L Y

LAPSE STUDY
Date: August 13, 2012
By : Albert Li, Simon Hirst
 F O R I N T E R N A L U S E O N L Y

Contents
1. Background
2. Methodology Definitions
3. Why Lapse Study
4. Who Uses It
5. How to do the process & formula
6. Special Note to Unit Link Business
7. Policyholders’ behaviour
8. Shock Lapse
9. Improvement to Persistency
10.Success Factors

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 F O R I N T E R N A L U S E O N L Y

Background for doing Lapse Study

Conducting lapse study is critical to profit emergence and
manage our business and plays an important role within
the business control cycle.

Useful for identifying possible revisions of future pricing and

valuation assumptions as well as improvements of
operational issues and benefit plan design, business plan,
VNB, and appraisal value.

Lapse study conducted and tracked monthly by various

dimensions with a full lapse study to be done annually.

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 F O R I N T E R N A L U S E O N L Y

Methodology Definitions
Definitions used in Persistency Calculation:

1. Converted Policy:
Policy that already paid the first premium and pass the free look period.

2. Unconverted Policy:
• Policies rejected by U/W staff before premium receipt, or cancelled by
U/W staff after premium receipt due to non-qualification
• Policies that are surrendered or cancelled by the customer while still in the
underwriting process
• Policies that received "Free Insurance Coverage" but never paid any
premium due for coverage beyond the free period or for amounts above
the "Free Insurance Benefit Amount.
• Policies that are surrendered after issuance with FULL PREMIUM REFUNDS
(I.e., during Free-Look period, application fraud, etc…)
• Policies that are cancelled due to First-Month Billing Failure (never in-force
because we never get any premium receipt)

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Methodology Definitions (Cont’d)

Unconverted Policy (cont’d):
• Policies that are generally considered as NOT-TAKEN-UP (NTU) or NON-
CONVERSION from the favorable-response applications
• Death and Maturity Policy

3. In force Policy:
Converted policy, with maximum unpaid premium not more than grace period

4. Lapse Policy :
• The converted policy with unpaid premium more than grace period.
• Voluntary cancellation after free look period (surrender).
• Exhausted Cash Value for APL option policy.
• Exhausted Fund for UL product.
• Cancellation with premium refund.

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 F O R I N T E R N A L U S E O N L Y

Methodology Definitions (Cont’d)

5. Grace Period
A provision in insurance contracts which allows payment to be received for a
certain period of time after the actual due date. During this period no late fees
will be charged, and the late payment will not result in default or cancellation
of the loan.

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 F O R I N T E R N A L U S E O N L Y

Why Lapse Study?

• Easily track and monitor monthly lapse activities

in each business block
1

• Support best estimate assumptions

2

• Assist management by providing insight on key

drivers and potential areas for operational
3 changes

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 F O R I N T E R N A L U S E O N L Y

Easily track and monitor monthly lapse activities in

each business block

• Different block of business would have different behavior

• Product: Life vs. annuity vs. health
• Distribution channel: Telemarketing vs. agency vs. bank
• Gender: Male vs. female
• Anti-selection: Standard vs. substandard
• Nature of renewal: guaranteed vs. optional vs. non-cancellable
• Types of guarantee: interest rate vs. no lapse vs. plan vanilla
• Benefits and riders: persistency bonus vs. plain vanilla

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 F O R I N T E R N A L U S E O N L Y

Support best estimate assumptions

• Pricing, sometimes with a margin

• Merging and acquisition – appraisal value
• Reserve valuation – PSAK 62 and other gross premium reserve type
calculation.
• Business Plan projection requires best estimate assumptions
• Dynamic solvency testing would require lapse rate assumptions with
a margin
• IFRS 4 Phase 2 focus on current fulfillment cash flow approach with
best estimate assumptions for non-market variables

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 F O R I N T E R N A L U S E O N L Y

Assist management by providing insight on key drivers

and potential areas for operational changes

• Product re-pricing
• Longer term premium guarantee vs. YRT
• Billing successful rates
• Incentive for customers such as raffle drawing
• Branding and socialization
• Customer service
• Agencies or telemarketers
• Business partner management
• Recoverability of acquisition cost and upfront commission
• Anti selection or extra mortality

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 F O R I N T E R N A L U S E O N L Y

Who uses it
Management Profitability Company growth Value of the business

Actuary Pricing Valuation Modeling Projection

Finance Explanation of earning

CVM Segmentation Focus group sale Increase close rates

CS Customer satisfaction

Distributor Compensation

Strategic
Product strategy Persistency Bonus
Marketing

Investment Asset portfolio ALM

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 F O R I N T E R N A L U S E O N L Y

How to do the process & Formula

Construct Persistency
UAT on The Triangle tracking month
Data
(monthly snapshot)
Request data
from IT

Credibility Persistency & lapse

calculation rate calculation

Propose

Review Sign off

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 F O R I N T E R N A L U S E O N L Y

1. Request data from IT

Actuary request data from IT based on the purpose of the study.

Actuary determine the segmentation and the duration

For instance:
a. The segmentation:
• By age
• By gender
• By Premium Mode
• By underwriting type (medical, non medical, guaranteed issue, non guaranteed issue )
• By risk classification (standard, substandard, preferred)
• By product type (term life, endowment, whole life, personal accident, etc )
• By distribution channel (Agency, bancassurance, telemarketing, DRTV)
• By business partner

b. The duration:
• Last 10 years, for example

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2. User Acceptance Test (UAT)

Make sure the

segmentation is correct
Make sure lapse date
Make sure the data has (example: product from
same as with the core
generated as requested channel Telemarketing
system
has been allocated
correctly)

Make sure total lapse Perform UAT with reported

versus combined lapse financials such as policy
of each group is equal counts and/or premiums

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 F O R I N T E R N A L U S E O N L Y

3. Construct Persistency Triangle tracking month (monthly snapshot)

“Persistency Triangle” should be developed beforehand, this triangle

tracks policies on an issue-month basis, e.g. policies issued in January
“Persistency Triangle” should be developed beforehand, this triangle tracks policies on an
2011 will bebasis,
issue-month aggregated
e.g. policiesand tracked
issued within
in January thebesame
2011 will cohort.
aggregated and tracked within
the same cohort.

The table below is a simplified example of the triangle on a premium-

amount basis. The base month represents the issue month in which the
policies are converted while the tracking month accounts for the
valuation month in which the remaining in force policies are reviewed
and recorded. For instance, out of the policies issued in January 2011,
Rp10.95Bn paid premiums remained in February and Rp10.45Bn
remained in April and so forth

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 F O R I N T E R N A L U S E O N L Y

2. Construct
Construct Persistency
Persistency Triangle
Triangle tracking
tracking month
month (monthly
(monthly snapshot)
snapshot) by
Premium Basis (Cont’d)

Example of persistency triangle by premium basis

February April

Duration
Premium Basis
Issued 1st 2nd 3rd 4th 5th 6th
Jan-11 11,200,000,000 10,950,000,000 10,700,000,000 10,450,000,000 10,200,000,000 9,950,000,000 9,700,000,000
Feb-11 11,300,000,000 11,020,000,000 10,740,000,000 10,460,000,000 10,180,000,000 9,900,000,000 9,620,000,000
Mar-11 11,400,000,000 11,100,000,000 10,800,000,000 10,500,000,000 10,200,000,000 9,900,000,000 9,600,000,000
Apr-11 11,500,000,000 11,170,000,000 10,840,000,000 10,510,000,000 10,180,000,000 9,850,000,000 9,520,000,000
May-11 11,600,000,000 11,250,000,000 10,900,000,000 10,550,000,000 10,200,000,000 9,850,000,000 9,500,000,000
Issue Month Jun-11 11,700,000,000 11,310,000,000 10,920,000,000 10,530,000,000 10,140,000,000 9,750,000,000 9,360,000,000
Jul-11 11,800,000,000 11,380,000,000 10,960,000,000 10,540,000,000 10,120,000,000 9,700,000,000 9,280,000,000
Aug-11 11,900,000,000 11,460,000,000 11,020,000,000 10,580,000,000 10,140,000,000 9,700,000,000 9,260,000,000
Sep-11 12,000,000,000 11,540,000,000 11,080,000,000 10,620,000,000 10,160,000,000 9,700,000,000 9,240,000,000
Oct-11 12,100,000,000 11,620,000,000 11,140,000,000 10,660,000,000 10,180,000,000 9,700,000,000 0
Nov-11 12,200,000,000 11,680,000,000 11,160,000,000 10,640,000,000 10,120,000,000 0 0
Dec-11 12,300,000,000 11,765,000,000 11,230,000,000 10,695,000,000 0 0 0

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 F O R I N T E R N A L U S E O N L Y

Construct Persistency Triangle tracking month (monthly snapshot) by

Policy Count (Cont’d)

The table below is a simplified example of the triangle on a policy-count

“Persistency Triangle” should be developed beforehand, this triangle tracks policies on an
basis. The base
issue-month month
basis, e.g. represents
policies the 2011
issued in January issuewillmonth in which
be aggregated the policies
and tracked within
are converted while the tracking the samemonth
cohort. accounts for the valuation
month in which the remaining in force policies are reviewed and
recorded. For instance, out of the policies issued in March 2011,
100,759 policies still in force in April and 95,330 policies still in force in
June and so forth

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 F O R I N T E R N A L U S E O N L Y

Construct Persistency Triangle tracking month (monthly snapshot) by

Policy Count (Cont’d)

Example of persistency triangle by policy count

April June

Duration
Policy Count
Issued 1st 2nd 3rd 4th 5th 6th 7th
Jan-11 101,818 99,395 97,123 94,875 92,602 90,330 88,057 85,784
Feb-11 102,727 100,032 97,486 94,966 92,420 89,875 87,330 84,784
Mar-11 103,636 100,759 98,032 95,330 92,602 89,875 87,148 84,420
Apr-11 104,545 101,395 98,395 95,420 92,420 89,420 86,420 83,420
May-11 105,455 102,123 98,941 95,784 92,602 89,420 86,239 83,057
Issue Jun-11 106,364 102,668 99,123 95,602 92,057 88,511 84,966 81,420
Month Jul-11 107,273 103,305 99,486 95,693 91,875 88,057 84,239 80,420
Aug-11 108,182 104,032 100,032 96,057 92,057 88,057 84,057 80,057
Sep-11 109,091 104,759 100,577 96,420 92,239 88,057 83,875
Oct-11 110,000 105,486 101,123 96,784 92,420 88,057
Nov-11 110,909 106,032 101,305 96,602 91,875
Dec-11 111,818 106,805 101,941 97,102

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4. Persistency and Lapse rate calculation (Cont’d)

1. Persistency Rate
• Persistency By Premium (used for regular premium policies)

• By Policy Count (used for single premium policies)

2. Lapse Rate

1 – Persistency Rate

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 F O R I N T E R N A L U S E O N L Y

Persistency and Lapse rate calculation Premium Basis (Cont’d)

Duration
Premium Basis
Issued 1st 2nd 3rd 4th 5th 6th
Jan-11 11,200,000,000 10,950,000,000 10,700,000,000 10,450,000,000 10,200,000,000 9,950,000,000 9,700,000,000
Feb-11 11,300,000,000 11,020,000,000 10,740,000,000 10,460,000,000 10,180,000,000 9,900,000,000 9,620,000,000
Mar-11 11,400,000,000 11,100,000,000 10,800,000,000 10,500,000,000 10,200,000,000 9,900,000,000 9,600,000,000
Apr-11 11,500,000,000 11,170,000,000 10,840,000,000 10,510,000,000 10,180,000,000 9,850,000,000 9,520,000,000
May-11 11,600,000,000 11,250,000,000 10,900,000,000 10,550,000,000 10,200,000,000 9,850,000,000 9,500,000,000
Issue Month Jun-11 11,700,000,000 11,310,000,000 10,920,000,000 10,530,000,000 10,140,000,000 9,750,000,000 9,360,000,000
Jul-11 11,800,000,000 11,380,000,000 10,960,000,000 10,540,000,000 10,120,000,000 9,700,000,000 9,280,000,000
Aug-11 11,900,000,000 11,460,000,000 11,020,000,000 10,580,000,000 10,140,000,000 9,700,000,000 9,260,000,000
Sep-11 12,000,000,000 11,540,000,000 11,080,000,000 10,620,000,000 10,160,000,000 9,700,000,000 9,240,000,000
Oct-11 12,100,000,000 11,620,000,000 11,140,000,000 10,660,000,000 10,180,000,000 9,700,000,000 0
Nov-11 12,200,000,000 11,680,000,000 11,160,000,000 10,640,000,000 10,120,000,000 0 0
Dec-11 12,300,000,000 11,765,000,000 11,230,000,000 10,695,000,000 0 0 0

1 2 3 4 5 6
Numerator 136,245,000,000 131,296,000,000 127,317,000,000 124,172,000,000 121,850,000,000 120,300,000,000
Denominator 141,000,000,000 135,548,000,000 131,078,000,000 127,479,000,000 124,720,000,000 122,750,000,000

Persistency
96.63% 96.86% 97.13% 97.41% 97.70% 98.00%
One Month
Persistency
96.63% 93.60% 90.91% 88.55% 86.51% 84.79%
Cumulative

12 24 36 48 60 72
1st year 2nd year 3rd year 4th year 5th year 6th year
Persistency 79.86% 67.25% 60.53% 57.47% 54.16% 51.21%
Lapse 20.14% 15.79% 9.99% 5.06% 5.77% 5.44%

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 F O R I N T E R N A L U S E O N L Y

Persistency and Lapse rate calculation Policy Count (Cont’d)

Duration
Policy Count
Issued 1st 2nd 3rd 4th 5th 6th
Jan-11 101,818 99,395 97,123 94,875 92,602 90,330 88,057
Feb-11 102,727 100,032 97,486 94,966 92,420 89,875 87,330
Mar-11 103,636 100,759 98,032 95,330 92,602 89,875 87,148
Apr-11 104,545 101,395 98,395 95,420 92,420 89,420 86,420
May-11 105,455 102,123 98,941 95,784 92,602 89,420 86,239
Issue Jun-11 106,364 102,668 99,123 95,602 92,057 88,511 84,966
Month Jul-11 107,273 103,305 99,486 95,693 91,875 88,057 84,239
Aug-11 108,182 104,032 100,032 96,057 92,057 88,057 84,057
Sep-11 109,091 104,759 100,577 96,420 92,239 88,057 83,875
Oct-11 110,000 105,486 101,123 96,784 92,420 88,057
Nov-11 110,909 106,032 101,305 96,602 91,875
Dec-11 111,818 106,805 101,941 97,102

1 2 3 4 5 6
Numerator 1,236,791 1,191,825 1,155,927 1,127,336 1,106,227 1,092,136
Denominator 1,281,818 1,230,480 1,189,868 1,157,400 1,132,318 1,114,409

Persistency
96.49% 96.86% 97.15% 97.40% 97.70% 98.00%
One Month

Persistency
96.49% 93.46% 90.79% 88.43% 86.39% 84.67%
Cumulative
12 24 36 48 60 72
1st year 2nd year 3rd year 4th year 5th year 6th year
Persistency 79.74% 68.33% 61.06% 57.60% 54.67% 51.48%
Lapse 20.26% 14.32% 10.64% 5.66% 5.08% 5.85%

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 F O R I N T E R N A L U S E O N L Y

5. Credibility calculation

•Blending actual experience with best estimate expectations

Statistical
Credibility in •Combines statistical methods and actuarial judgment
Actuarial
•Several methods at different levels of base statistics
Science

•Observed results for a small data set help to estimate future

Why expectations, but have a random element
Credibility is •Results for a larger data set have greater statistical significance, but the
important ? population may have different characteristics than the subset
•We need to combine these to make the best use of all available data

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 F O R I N T E R N A L U S E O N L Y

Credibility calculation (Cont’d)

• When communicating with non-actuaries, be careful about

Be Careful confusion with the dictionary meaning of “credibility”.
with • When we use the term credibility, we are not questioning the
Terminology accuracy of the data, but noting its partial statistical weight as a
projection of future expectations.

• Make the most accurate projection, taking cost-benefit into

What is the consideration
Goal of • Balance of stability and responsiveness is a natural outcome
Credibility • Concern about stability is a marketing consideration, not a basis for
making the most accurate projection

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 F O R I N T E R N A L U S E O N L Y

Credibility calculation (Cont’d)

• Z Factor

n = Number of lapse

Min = Minimum

3,007 = from normal table corresponding to p = 0.9 and r = 0.03

• Canadian Institute of Actuaries - Educational Note on credibility theory

• This corresponds to the normal distribution value where we can be 90% confident of
being within 3% of the mean, so that the margin of error

• Blended

Blended = { Z*Lapse experience + (1-Z)*Lapse assumption }

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 F O R I N T E R N A L U S E O N L Y

Credibility calculation (Cont’d)

12
24 36 48 60 72
1st year 2nd year 3rd year 4th year 5th year 6th year
Persistency 79.9% 67.3% 60.5% 57.5% 54.2% 51.2%
Lapse 20.1% 15.8% 10.0% 5.1% 5.8% 5.4%

Description 1st Year 2nd Year 3rd Year 4th Year 5th Year 6th Year
Total # policy lapse 4,882 3,010 2,400 1,750 1,500 1,100
Z Factor 100% 100% 89% 76% 71% 60%
1-Z Factor 0% 0% 11% 24% 29% 40%
Lapse Experience 20.1% 15.8% 10.0% 5.1% 5.8% 5.4%
Lapse Pricing Assumption 15% 10% 10% 5% 5% 5%
Blended 20.1% 15.8% 10.0% 5.0% 5.5% 5.3%
Propose

Factor 3,007
(from normal table corresponding to p = 0.9 and r = 0.03)

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 F O R I N T E R N A L U S E O N L Y

6. Propose, Review, Sign Off

Doer
to propose the future expectations

Checker
to review the proposal

Chief Actuary
to approve (sign off) the proposal

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 F O R I N T E R N A L U S E O N L Y

Special Note to Unit Link Business

• Persistency Study is done using policy count
• Premium persistency assumption is built to account for the
flexible premium structure. In general, most companies assume
a decreasing ratio starting from 100% based on experience
studies
• Companies may study lapse and surrender rates separately
• Minimum funding concept exist for some unit link products to
keep policies inforce
• Split the studies based on whether there is secondary guarantee
• Policyholders’ behaviour is important

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 F O R I N T E R N A L U S E O N L Y

Policyholders’ Behaviour

Surrenders / Market Rate of competitor

Function of Treasury Curve Guaranteed Interest rate
Lapses higher, surrender higher

Take up rate depends on

Guaranteed Minimum annuity Market interest rates,
fiscal incentives / legal
Annuity Option conversion rate assumed mortality
obligations (annuity vs cash)

Option to extend Ad-hoc premiums on

Or extend the duration,
duration or pay interest rates guaranteed Take up rate high when
continuing the interest rate
additional at outset of the base interest rate falls
guarantee
premium policy

Variable People surrendered in 2008 Most polices are in the

GMXB
annuities as they need money money

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 F O R I N T E R N A L U S E O N L Y

Shock Lapse
Significant increase (often one time) in a lapse rate to an event affecting
policyholders
• Large rate increase after the level guaranteed premium period
• Anti - seleciton
• Large rate increase after the surrender charge period
• Market Rate of competitors
• Initial shock lapse at the end of the level term period is sometimes followed by a
smaller secondary shock lapse
• Lapse rates tend to grade down in later duration of the post level term period
• Lapses within the first year of the post-level period are more heavily skewed
toward the beginning of the policy year, indicating a disproportionate amount
of off-anniversary lapse activity compared to the level period.
• Price for anti selection on mortality deterioriation

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 F O R I N T E R N A L U S E O N L Y

Improvement to Persistency
Risk Cause Mitigation Strategy

Voluntary Premium too high Long term guarantee

cancelation Loyalty program
Product is not right or Distributor training and control
not needed Customer Centricity Program

Other products are more Conversion/Product Development

attractive Persistency Bonus
Return of Premium
Not confident with the Branding and socialization
company
Involuntary Billing Issue Billing Force Through credit card
cancelation with fee reimbursement
Daily billing on saving account
Alternative payment channels

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 F O R I N T E R N A L U S E O N L Y

Success Factors
Cause Requirement Action Plan

Credible Large volume of data Build Data warehouse

Experience since issue
Control and Management decision, Build SOP with Actuarial, IT and
compliance shareholder’s and CVM
regulatory reporting
Profitable Customer Centricity Balance portfolio such as lapse
Inforce supported products vs. term vs.
YRT vs. annuity vs. unit link
Poaching Maintain strong and Compensation plan related to
activities stable distribution persistency
channels

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 F O R I N T E R N A L U S E O N L Y

Lesson Learned

• Lapse rates were not very low in the US during the

2008 credit crisis as people needed money
• T100 priced in early 80s in Canada was lapse
supported and aggressive assumptions caused issues
with decreasing interest rates
• Integrated A/L modeling on pricing is first step to
understand risks, quantify risk and mitigate risk,
especially persistency
• ALM is the key to match assets with liabilities with
consideration of policyholders’ behaviour

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 F O R I N T E R N A L U S E O N L Y

F O R I N T E R N A L U S E O N L Y

"Cigna" is a registered service mark and the "Tree of Life" logo and “GO YOU” are service marks of Cigna Intellectual Property, Inc., licensed
for use by Cigna Corporation and its operating subsidiaries. All products and services are provided by such operating subsidiaries and not by
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illustrative purposes only.

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