4 - Basis of products Flashcards
Name the main 4 bases of products
- Coventional without-profits
- With-profits
- Unit-linked
- Index-linked
Implacations based on the type of basis
- cost and risk to policyholder (guarantees have highest expected cost, but lowest risk) (Unit-linked have highest possible cost, since adverse experience is passed on to p/h)
- flexibility possible in contract design (U-L highest)
- risk, capital requirements and potential profit to the insurer (Guarantees have highest risk, U-L have highest profit potential and lowest capital reqs)
The risk carried by the insurer from most to least (ito product basis)
conventional > With profit > Unit-linked
An example of a risk that may be higher for with-profit than an equivalent without-profit: Marketing risk.
Explain marketing risk for with-profits endowments
- Essentially savings vehicles
- Large portion of benefits paid out will depend on bonuses
- payout can be lower than hoped for
- disappointed policyholders
- bad publicity
- result in poor sales and higher withdrawals
Unit-linked contracts
Key features:
Premiums, units, charges, benefits, recouping initial expenses, surrenders, maturity value, profit
- Premium is paid into investment fund.
- Premium buys a number of units
- number of units bought depends on unit price
- unit price = market value of assets / total number of units
- P/h share of units remain the same until a cashflow (premium, claim, charge) occurs
- Insurer will deduct charges premiums:
- Reduced allocation rate
- Bid offer spread
- Fixed amount
- Insurer can also deduct charges from the fund (cancelling units of equal value to the charge levied)
- Percentage of fund value
- regular fixed charge
- mortality charges (which is a function of the fund value and guaranteed death benefits
Benefits
- protection benefits possible (min guaranteed benefit on death)
- to provide reasonable death benefit at early durations when fund value is low
- insurer will meet balance if death benefit is higher than fund value
- cost of claims recouped through risk/mortality charge
Recouping intial expenses:
- low or zero allocation rate for short initial period
- moderately reduced allocation rate for significant part of policy
- higher regular fund charge
- - throughout the whole term
- - through the use of capital units which will be subject to higher fund charges than normal units
Value of policy at maturity:
- bid value of units
Surrenders:
- subject to surrender penalty
- value of fund
Profit
- charges are kept to cover expenses, claims and profit
Unit-linked contracts
Unit and non-unit funds
Unit fund
- Defined the p/h’s basic benefit
- bid value of p/h unit-fund: amount of money that insurer would pay to policyholder on a claim under the policy
Non-unit fund:
- “other” money
- accumulated value of charges less the actual costs incurred less distributions of profit plus capital injections
- a policy’s contribtuion to non-unit fund = policy asset share - unit fund
Unit-linked contracts
Customer needs
- enables consumers to either:
- obtain a higher expected level of benefit for a given premiums, or
- pay a lower expected level of premium for a given level of benefit,
than under a comparable non-linked version of a contract
2.Offers flexibility in the types and level of cover included and the ability to vary premiums according to need
Unit-linked contracts
Implications of having the flexibility to choose the level of cover
- Risk charge is usually calculated as = qx/12 * (sum at risk)
- for a given premium, the higher the chosen cover, the smaller the unit fund will be
- at a low level of cover, the fund would be larger
- if a small sum insured is chosen, unit cancellation would be much lower, and so a larger savings element would build up
Unit-linked contracts
Risks to the insurer
Reduced guarantees -> Reduced risk
Nature and extent of risks depend on nature and extent of guarantees offered
Investment risk:
- Some, since charges will be depend on fund value (and returns)
- would signigicantly increase if non-unit related guarantees are offered
Expense risk
- Risk than income from charges are insufficient to meet expenses
- mitigate by ensuring charges are also linked to infaltion
- or having fixed amount charges to cover overheads (volume risk)
Mortality risk
- due to death benefits offered
- serious deterioration of experience is likely to cost the insurer money
- Anti-selection risk is same as for non unit-linked
Withdrawal risk:
- likely to be higher due to more open charging structures
- when asset share is negative, there is financial risk from withdrawal
- withdrawal risk depend on the incidence of expenses relative to charges ann on surrender penalties
Unit-linked contracts
Suitable surrender penalties for the following charging structure:
Allocation rate throughout = 95%
Fund management charge = 0.5%
Initial expenses are large recouped thorught he 5% of unallocated premium.
Surrender penalty = PV of lost futuremonetary amounts, e.g. 20% of one year’s premium after six years
Unit-linked contracts
Suitable surrender penalties for the following charging structure:
Allocation rate = 100% throughout
Fund management charge = 2%pa
Surrender penalty = % of fund value
reducing as contract reaches maturity
Unit-linked contracts
Suitable surrender penalties for the following charging structure:
Allocation rate = 0% for two years, 100% thereafter,
Fund management charge = %
No fund within first two years
after 2 years, initial expenses would have been recouped,
No surrender penalty
Unit-linked contracts
Capital requirements
Depends critically on the contract design
- Allocation rate: low allocation rate intially = capital efficient
- Make use of actuarial funding to reduce the reserve
Index-linked contracts
The needs of customers
Benefits are guaranteed to move in line with a specified investment/economic index.
Protects policyholder’s benefit against inflation
Index-linked contracts
Two examples
Index-linked annuity
- Regular payment that moves in proportion to published index of price or earnings
- single payment or deferred annuity with regular payments (which may also increase in proportion to index)
- company takes margins for expenses, mortality and profit in the rates it offers for conversion from the premium to the initial level of annuity
Index-linked investment bond
- single premium
- guarantee to pay premium increased in line with index on maturity or earlier death
- margins taken from difference in investment return obtained and the return determined bb the progress of the index over the period
Index-linked contracts
Risks
Investment risk
- may not be able to invest so as to match precisely the benefit guarantee given
- due to practicality
- may be inpratical and expenses to keep sam weighting in portfolio
- may be possible to use derivatives, but also comes with a cost
Note: risk of adverse movements in the index itself is a risk to the policyholder
Risk of products to the insured
Conventional without-profits
- The amount of fixed and guaranteed benefit provided eventually turns out to be insufficient, due to effects of inflation
- Insolvency of the insurer being unable to cover benefits
- inflexibility of product to keep pace with changing disposable income and changing of benefit needed throughout financial life cycle
- risk of being unable to mantain premiums due to accident, sickness, redundancy (reduced with premium waiver option)
Risks to the insured
With-profits
- Insolvency (but less than conventional)
- there is some protection against inflation - only for distribution methods that increase the amount of benefits
Risks to the insured
Unit-linked contracts
- Investment risk - poor performance and volatility leading to reduced benefits on the date of claim
- inflation: minimum death benefit is specified in monetary terms. Most protection provided when unit fund is invested in index-linked securities and premiums paid to fund increase in line with appropriate index
- Insolvency
- increases in minimum guaranteed death benefit are subject to evidence of health
Advantages:
- flexible policies, so premiums and benefits can vary according to need
- allows missed premiums
- This will also lead to less lapses and overall more premiums received by insurer over lifetime
Risk to the insured
Index-linked policies
- reduced risk of erosion of benefit value
- a risk remains that selected indec does not replicate the rate of spending inflation to which the the p/h is exposed
Purpose of products to the insurer
- Seek to offer an attractive range of products which maximises profits in the long run
- profits are maximised when utility of products to the consumer is also maximised
- seek to take on furhter profitable risks within available capital, to maximis economies of scale
- diversify and contral risks, using appropriate volums and mix of suitable design contracts
Aspects of insurance company management that affect its profitability and risk profile
DI CHEAP SUPRA
- Discontinuance terms offered
- Investment strategies
- Capital management
- HR management and remuneration
- Effectiveness of monitoring and feedback systems in reacting to events
- Approach to reserving and profit distribution
- Product design
- Selling and marketing
- Underwriting practices
- Pricing
- Reinsurance arrangements
- Administrative systems in place, data handling anf maintenance
Products for the personal financial life cycle
16-25
- No life insurance needs / no dependants
- need for short term savings (house purchase)
25-35
- High debt, expenditure and financial dependance
- need for life insurance
- low wealth = risk averse = guaranteed terms
- Needs for sickess and death benefit protection = temporary insurance
- duration = expected period of dependancy
- uncertain future needs = convertible, icreasable or renewable term assurances
- higher wealth = unit-linked form
- Fund full repayment of loan using endowment = unitlinked/ WP since WOP is too expensive
- other savings (education+retirement) = endowment UL or WP
- group LI products to employers (gruaranteed for small and UL for large employers
35-65
- savings for retirement, wealth transfer and other savings
- WP or UL (returns are important)
- retirement = endowments or defferred annuities
- more emphasis on guarantees closer to retirement
- transfer of wealth = whole life assurances (UL or WP)
- Less dependancy = higehr disposable income = other savings = Single premium investments providing lump sum benefit in the futue (UL, WP, IL)
Over 65:
- Pension = immediate annuities
- fixed income, IL, UL, WP are all possible
- minimum payment periods may be chosen
- Need for wealth transfer
