23. Contract design ToDO 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)
2) 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?
- Chosen market
- Capital available
- Expertise available
What factors influence the needs of the provider’s customers?
- The capacity to pay
- The risks they need to be covered
- The benefits that are needed at different times in the future â– Attitude to financial risk
How can a contract be designed to cater for different risk appetites amongst customers?
- Levels of cover=> third party or full cover
- Different investment funds=> low medium high
How might the regulatory environment influence the design of a product?
- Products must meet the legal or regulatory requirements
- Products designed to benefit from favourable financial or taxation regimes
- Products designed such 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=> discontinuance terms
What does profitability in contract design mean?
- Premiums charged= E[Benefits]+ expenses + profit margin
What contract design features may make a contract more marketable?
- Guarantees, options and choices
- A competitive (low) price
- Transparency + simple to understand
- Features that distinguish the contract from that of competitors-NOT TOO
- DIFFERENT
What are examples of options relating to premiums, benefits, the use of proceeds and any other options that may be offered as part of contract design?
- Premium options=> waiver of premium
- Option to increase/reduce premiums
- Option to choose/change frequency of payments
- Benefit options=>discontinuance o Early, late or ill health benefits o Spouse’s benefits o Rider benefits o Options to protect a NCD
- o Option to commute between income + lump sum
- Use of the contract proceeds=> choice of annuity provider o Choice of hospital under medical aid
- Other options=> options to renew/ convert a TA without further underwriting
What are examples of guarantees that may be offered as part of a contract design?
- Guaranteed benefits=> 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 iii. The provider of the benefits
- What does surrender mean? â– 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?
- It will consider:
- Market practice
- Regulatory requirements
- Anti-selection risk
- Difficulty+ 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?
- Fairness=> asset share of the contract CV(A) determined retrospectively from the accumulation of net cashflows â– Other factors include:
- Policyholder expectations
- New business disclosure+ any subsequent communications=> illustration of discontinuance terms
- Competition
- Regulation/legislation affecting discontinuance terms
- Admin expenses of determining and implementing the terms vi. 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?
- 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 â– Ease of calculation and frequency of change of terms
What is new business strain?
- Shortfall that occurs when a contract is written
- Initial expenses+ provisions + required solvency cap> premium received â– New business strain=> capital requirement
- How can a contract be designed to limit new business strain? â– Avoid options and gurantees
- Match charges with expenses+ keep charges variable
- Low initial expenses/ commission
- Offer contracts with low statutory provisioning requirements â– Use single premiums rather than regular premiums
- What are the methods of financing benefits? â– Pay-as-you-go
- Funding all benefits in advance
- Regular payments building up in a fund
- Paying an amount when the benefit event happens
- Purchasing an annuity as the point of retirement
What are the main administrative considerations that relate to contract design?
- 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.
- What items would expense charged be expected to cover? COST RAID
- Commission
- Overheads
- Sales/advertising
- Terminal=> paying benefits
- Renewal administration=> collecting premiums+ redistribution
- Asset management
- Initial administration=> setting up policyholder records
- Design of contract
What is the significance of cross-subsidies within a class of business in relation to contract design?
- Certain policies contribute more to overheads and profits than others
- Charges on a unit linked policy are variable=> large policies contribute more to profit than small policies
- Business MIX NB
- Actual business Expected=> Higher or lower profits than expected
What are examples of conflicts between contract design factors?
- Profitability vs competitiveness
- Avoiding cross-subsidies (with a simple charging structure) vs simplicity of administration
- Offering options + guarantees vs minimising risk
- Offering options+ guarantees vs financing requirement
- Offering options+ guarantees vs simplicity of administration â– Marketability vs strict terms and conditions
- Chapter 24 Pricing and financing strategies
