23. Contract design Flashcards
1) What factors should be considered when designing or redesigning a contract?
AMPLE DIRECT FACTORS
- Administration systems
- Marketability
- Profitability
- Level and form of benefits
- Early leaver benefits
- Discretionary benefits
- Interests and needs of customers
- Risk appetite of the parties involved
- Expenses vs charges
- Competition
- Terms and conditions of contract
- Financing (Capital requirements)
- Accounting implications
- Consistency with other products
- Timing of contributions or premiums
- Options and guarantees
- Regulatory requirements
- Subsidies(cross)
Who are the key parties involved with contract design?
ALPACAS
- Actuaries
- Lawyers
- Providers of benefits
- Accountants
- Customers
- Administrators
- Shareholder/financial backers
What factors influences the need of the provider?
4
- Chosen market
- Capital available
- Expertise available
- Liquidity available
What factors influence the needs of the provider’s customers?
4
- The capacity to pay
- The risks they need to be covered
- The benefits that are needed at different times in the future
- Attitude to financial risk
Give examples of how a contract can be designed to cater for different risk appetites amongst customers?
2
- Levels of cover=> third party or full cover
- Different investment funds=> low medium high
Give examples of how the regulatory environment might influence the design of a product?
4
- Products must meet the legal or regulatory requirements
- Products can be designed to benefit from favourable financial or taxation regimes
- Products should be designed to ensure that initial expenses can be recouped if a policy cancelled in the regulatory cooling of period
- Regulation may require information to be disclosed to potential customers e.g. discontinuance terms
What does profitability in contract design mean?
- Premiums charged= E[Benefits]+ expenses + profit margin
- In most foreseeable circumstances
What contract design features may make a contract more marketable?
4
- Guarantees, options and choices
- A competitive (low) price
- Transparency + simple to understand
- Features that distinguish the contract from that of competitors-NOT TOO DIFFERENT FROM COMPETITORS
What are examples of options relating to premiums, benefits, the use of proceeds and any other options that may be offered as part of life insurance contract design?
Premium options
* waiver of premium
* Option to increase/reduce premiums
* Option to choose/change frequency of paymentsBenefit options
* discontinuance
* Early, late or ill health retirement benefits
* Spouse’s benefits
* Rider benefits
* Options to protect a NCD
* Option to commute between income and lump sumUse of the contract proceeds
* choice of annuity provider
* Choice of hospital under medical aid
Other options
* options to renew/ convert a TA without further underwriting
Give two examples of options that could be included in the design of banking products
- Repayment of loans before the contractual maturity date, with no additional charges
- Early withdrawal of fixed-deposits, with only limited penalties
What are examples of guarantees that may be offered as part of a contract design?
6
- Guaranteed benefits=> Fixed amount or in terms of an index
- Guaranteed minimum maturity value=> on a unit linked contract
- Guaranteed minimum growth rate
- Guaranteed annuity rates
- Guaranteed premium rates
- Guaranteed charges=> on a unit linked contract
What is the underlying principle to consider when setting discontinuance terms for an insurance company benefit scheme?
Fairness between:
* Policyholder or member who is leaving
* The remaining policyholders or members
* The provider of the benefits
What does surrender mean
- The policy stops
- No further cover
- Policyholder receives a lump sum (surrender value)
What does the term lapse mean?
- The policy stops
- No further cover
- No payment from insurance company to policyholder
What does the term paid-up mean?
- Policyholder ceases to pay premiums
- Policy continues to offer policyholder cover
- Benefit reduced to reflect no more premiums
- Called paid-up value
What does the term withdrawal mean?
- Surrender + lapse
- Policy no longer in force
How does an insurance company decide on which contracts to offer discontinuance terms?
5
It will consider:
- Market practice
- Regulatory requirements
- Anti-selection risk (i.e. risk of selective withdrawals)
- Difficulty and cost of assessing and implementing suitable terms
- Past practice
When an individual terminates a life insurance contract, what are the main factors to consider when determining suitable discontinuance terms?
7
- Fairness=> asset share of the contract - Current value determined retrospectively from the accumulation of net cashflows
Other factors include: - Policyholder expectations
- New business disclosure+ any subsequent communications=> e.g. illustration of discontinuance terms
- Competition
- Regulation/legislation affecting discontinuance terms
- Admin expenses of determining and implementing the terms
- Ease of calculation and frequency of change of terms
What are a life insurance policyholder’s expectation when it comes to discontinuance benefits from a policy at different stages of the policy’s lifetime?
- Near the start=> Policyholders would expect a return of premiums+ some interest
- Towards the end of the contract=> discontinuance benefit consistent with maturity benefit
When an individual leaves a benefit scheme what are the main factors to consider in determining suitable discontinuance terms?
6
- Fairness between leaving member and those staying
- Member wants to stay in the scheme as a deferred member or take a transfer value to another scheme
- Schemes funding level at the point of discontinuance
- Regulation/legislation affecting discontinuance terms
- Admin expenses of determining and implementing the terms
- Ease of calculation and frequency of change of terms
What is new business strain?
- Shortfall that occurs when a contract is written
- Initial expenses (inc commission) + initial provisions (inc required solvency cap) > initial premium received
- New business strain results in capital requirement to meet shortfall
How can a contract be designed to limit new business strain?
5
- Avoid options and gurantees
- Match charges with expenses and keep charges variable
- Low initial expenses/ commission
- Offer contracts with low statutory provisioning requirements
- Use single premiums rather than regular premiums
What are the four methods of financing benefits?
- Pay-as-you-go
- Funding all benefits in advance
- Regular payments building up in a fund
- Paying an amount when the benefit event happens - e.g. Purchasing an annuity at the point of retirement
What are the main administrative considerations that relate to contract design?
5
- Outsource admin VS perform in house
- Can existing admin systems carry out the functions that have been built into the product design?
- Need to produce new or updated product literature
- Cost of making systems and admin process changes
- Whether some of the changes can be deferred because they are not required at short policy durations.
