4 - Basis of products Flashcards

1
Q

Name the main 4 bases of products

A
  • Coventional without-profits
  • With-profits
  • Unit-linked
  • Index-linked
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2
Q

Implacations based on the type of basis

A
  • 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)
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3
Q

The risk carried by the insurer from most to least (ito product basis)

A

conventional > With profit > Unit-linked
An example of a risk that may be higher for with-profit than an equivalent without-profit: Marketing risk.

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4
Q

Explain marketing risk for with-profits endowments

A
  • 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
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5
Q

Unit-linked contracts

Key features:
Premiums, units, charges, benefits, recouping initial expenses, surrenders, maturity value, profit

A
  • 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

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6
Q

Unit-linked contracts

Unit and non-unit funds

A

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

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7
Q

Unit-linked contracts

Customer needs

A
  1. 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

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8
Q

Unit-linked contracts

Implications of having the flexibility to choose the level of cover

A
  • 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
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9
Q

Unit-linked contracts

Risks to the insurer

A

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

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10
Q

Unit-linked contracts

Suitable surrender penalties for the following charging structure:
Allocation rate throughout = 95%
Fund management charge = 0.5%

A

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

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11
Q

Unit-linked contracts

Suitable surrender penalties for the following charging structure:
Allocation rate = 100% throughout
Fund management charge = 2%pa

A

Surrender penalty = % of fund value
reducing as contract reaches maturity

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13
Q

Unit-linked contracts

Suitable surrender penalties for the following charging structure:
Allocation rate = 0% for two years, 100% thereafter,
Fund management charge = %

A

No fund within first two years
after 2 years, initial expenses would have been recouped,
No surrender penalty

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14
Q

Unit-linked contracts

Capital requirements

A

Depends critically on the contract design
- Allocation rate: low allocation rate intially = capital efficient
- Make use of actuarial funding to reduce the reserve

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15
Q

Index-linked contracts

The needs of customers

A

Benefits are guaranteed to move in line with a specified investment/economic index.
Protects policyholder’s benefit against inflation

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16
Q

Index-linked contracts

Two examples

A

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

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17
Q

Index-linked contracts

Risks

A

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

18
Q

Risk of products to the insured

Conventional without-profits

A
  1. The amount of fixed and guaranteed benefit provided eventually turns out to be insufficient, due to effects of inflation
  2. Insolvency of the insurer being unable to cover benefits
  3. inflexibility of product to keep pace with changing disposable income and changing of benefit needed throughout financial life cycle
  4. risk of being unable to mantain premiums due to accident, sickness, redundancy (reduced with premium waiver option)
19
Q

Risks to the insured

With-profits

A
  1. Insolvency (but less than conventional)
  2. there is some protection against inflation - only for distribution methods that increase the amount of benefits
20
Q

Risks to the insured

Unit-linked contracts

A
  1. Investment risk - poor performance and volatility leading to reduced benefits on the date of claim
  2. 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
  3. Insolvency
  4. 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

21
Q

Risk to the insured

Index-linked policies

A
  • 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
22
Q

Purpose of products to the insurer

A
  • 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
23
Q

Aspects of insurance company management that affect its profitability and risk profile

A

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
24
Q

Products for the personal financial life cycle

A

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