Additional Flashcards
Steps in pricing and design
- assimilate marketing information
- determine assumptions
- determine appropriate model points
- perform profit-test
- perform model office projections
- consider the risks
- amend the structure
List the items that an insurer will need to choose a methodology and basis for in order to calculate EV
A methodology is required to
- value the assets
- value the liabilities
A basis is required for the following items in order to calculate the PV of future profits
- investment returns earned on reserves
- mortality
- expenses
- expense inflation
- surrender rates
- rates of conversion to paid-up
- risk discount rate
a basis is also required to value the liabilities
Financial strength
refers to a company’s ability to:
- withstand adverse changes in experience
- fulfil its new business plans
- meet policyholders’ expectations
Conditions for actuarial funding & constraints on its use
- high fund management charges should be available on at least some of the units
- after actuarial funding, the residual regular non-unit cashflows should remain positive in all future years when projected on a prudent basis
- this usually means that not all future fund management charges can be actuarially funded
- an appropriate unit surrender penalty should be in place, such that the surrender value cannot be greater than the actuarially funded unit reserve value at surrender
- there may be statutory constraints
Determining the risk margin using the cost of capital approach
pg.1280
Principles a life insurance company should follow when establishing supervisory reserves
- the reserves should cover all liabilities arising from the contract
- the reserves should be calculated prudently, allowing for all relevant liabilities
- the reserves should take credit for future premiums if these are contractually due to be paid
- the valuation should be prudent and so the basis should contain margins
- the valuation of the liabilities should be consistent with that of the assets
- appropriate approximations or generalisations may be allowed
- the interest rate used for calculating reserves must be chosen prudently, taking into account the currencies, yields and reinvestment yields on assets
- the demographic, withdrawal and expense assumptions used should all be prudent, taking into account the type of insurance and country of residence but the expenses can be on an ongoing business basis
- if no explicit allowance is made for future bonuses, then they must be allowed for implicitly by a suitable adjustment to the valuation interest rate
- if the valuation method itself defines the amount of expenses assumed, then the amount implied must be no less than a prudent estimate of the relevant expenses
- the valuation calculations conducted over time should not suffer discontinuities arising from arbitrary changes to basis
- however, the basis should be active and appropriate to current circumstances
- the valuation method should recognise the emergence of profit appropriately over the policies’ lifetimes, so as to match the assumed future regular bonus
- valuation bases and methods should be disclosed
Why is financial underwriting important?
- to make sure that the policyholder is not over-insured. over-insurance poses a moral hazard
- affordability
- selective lapsation
Practical problems faced in allocating actual investment returns to the asset share build up
- assets on WP and NP are likely to be combined. Decision needs to be made on how to allocate investment returns to areas of business and between tranches of business
- this may also be dependent on the appropriate asset mix of each of the tranches of business
- the actual investment return cannot always be directly observed. Some approximate method will need to be used to determine return on these assets e.g. use of indices
- available indices may not accurately reflect the actual underlying assets held
- the return allocated to asset share may be smoothed over time. The extent of smoothing is subjective
- investment returns should be net of tax
- need to allow for the accrual of tax on unrealised gains
- the actual investment return needs to be reduced by investment expenses. some approximations may be needed
- the data quality and detail necessary for calculation may not be available
- accurate calculations may only be done periodically. Some approximation is required for the intermediate terms
Principles when providing bonus recommendations to board
- PRE
- equity
- financial soundness of company
- availability of shareholder capital
- consistent with company’s investment strategy
- consistent with stated bonus philosophy
- competitive
- sustainable
- consistent with professional guidance/regulation
- tax
- business objectives/strategy
Internal unit-linked fund
An internal unit-linked fund:
- consists of a clearly identifiable set of assets e.g. equities
- is divided into a number of equal units consisting of identical subsets of the fund’s assets and liabilities
- the division is notional
Principal risks to insurer of setting unit prices
June 2012 Q5 ii
- unit prices are generally set at discrete points in time, whereas the values of the underlying assets effectively change continuously
- this is a particular risk if…
- the unit price calculation would include some approximations
- there could be errors in the actual unit price calculations
- regulations may restrict what policy charges, for example, may be included in the unit price
- negative market perception if violates equity principle
- impact of approximations/errors
Requirements for actuarial funding
- there must be a unit-related charge on the unit fund
- the charges that are not used for actuarial funding should be sufficient to cover the renewal expenses on the contract
- the face value of units should only be available on contingent events
- actuarial funding must be permitted by regulation
possible cross-subsidies
- old and young
- other known rating factors
- ill and healthy at entry
- policy size
- early and late withdrawals
Factors to consider in setting retention limit
- expected claims distribution & volatility
- expected volumes of business
- experience on other reinsurance
- the confidence and familiarity of the company in writing this business
- other products’ retention limits
- impact on regulatory capital requirements of different retention limits
- risk appetite of the company
- importance of stable free asset ratio
- free assets of the company
- price of reinsurance
- whether profit share is included
- impact of various retention levels on profitability and probability of insolvency
- the opinions of the reinsurer as they should have experience in this regard
Advantages of standardising claims criteria across the industry
- such standardization would have to be agreed by the various insurers, so the companies’ expertise would be pooled to come up with the best solution
- there will be a sharing of current and future expertise on the topic of medical advances, which will bring costs down for the various players in the market
- the standardized definitions are likely to be free of ambiguity
- this should lead to quicker claims settlement because there should be less room for dispute
- from a marketing perspective, standardized definitions could result in:
- easier comparison between different companies’ products
- improved explanation from salesforce
- better understanding by policyholders of the products
- possible improvement in sales
- standard definitions should make it easier to collect industry-wide data, which should lead to better information on which to base pricing
- these benefits also apply to reinsurers
Appropriateness of alteration basis
- PRE
- contribution to profit
- expenses
- boundary conditions
- lapse and re-entry risk
- small change in benefit
- frequency of changes
- ease of administering and communication
- competition
Four main factors that affect the capital requirements for a company
- contract design
- frequency of premium payment
- relationship between premium and supervisory reserving basis
- the level of initial expenses
Considerations when making a policy paid-up
- the basis needs to be such that the conversion to paid up is affordable and can be supported by the earned asset share
- should be consistent with the projected maturity value, allowing for premiums not received
- should be consistent with other alterations such as surrender values
- surrender value should be consistent before and after such alteration to avoid lapse and re-entry
- basis should result in a paid-up value that is consistent with any information disclosed at new business stage in line with PRE
- paid up rates offered by competitors should be considered
- basis and any changes should be documented clearly
- the calculation should be simple to understand
Proportionate method vs equating policy value method for paid-up
Nov 2010 pg.7
pg 781
Asset-enhancing reinsurance
- it may be used to unlock a portion of the value of the profitable in-force business or discounted cashflows on policies
- the VIF is the excess of the statutory reserves over the realistic reserves
- VIF will be released over time, but is currently an off-balance sheet, non-tangible asset
- in exchange for entering into a reinsurance contract on existing business, the reinsurer gives the insurer cash now
- this is paid back over the next few years from the future emergence of the VIF as future profits
Negative non-unit reserves (to reduce initial business strain)
- can be held for policy under which future charges are expected to be more than sufficient to meet future non-unit liabilities
- negative non-unit reserves thus reduce the total reserves required by taking advance credit for the EPV of these future positive cashflows
- the reserve represents a loan from other contracts which have positive non-unit reserves
- the loan will be repaid by the emerging future profits from the policy for which the negative non-unit reserve is held
Constraints of negative non-unit reserve
- may not be permissible under local legislation
- the sum of the unit and non-unit reserve for a policy should not be less than any guaranteed surrender value
- the future profits arising need to emerge in time to repay the loan
- after taking account of the future non-unit reserves, there should be no negative cashflows for the policy
- in aggregate, the sum of all non-unit reserves should not be negative
- the negative non-unit reserve should be determined prudently
Regulatory restrictions (besides on investments)
- restrictions on the type of contracts a life insurer can sell
- restrict the premium rates that can be used on some type of contracts
- requirements relating to the terms and conditions offered
- restrict the distribution channel:
- the channels through which the life insurance may be sold
- the procedure to be followed for a sale
- minimum qualifications requirements for the sales staff
- the information to be provided as part of the selling process
- remuneration rules - restrictions on the ability to:
- underwrite
- differentiate between classes of lives - constraints on the amount of business that can be written
- restrictions on permissible reinsurance
- requirements to TCF
Advantages of cashflow method over formula method to calculate reserves
Advantages
- the cashflow method allows for assumed experience to vary over time e.g. mortality improvements
- this allows a stochastic model to be built for deriving the distribution of reserve level and for valuation of options
- allows for withdrawal experience explicitly
- it allows more easily for complex benefit structures e.g. where charges and benefits depend on future assumptions such as unit-linked business
- the risk discount rate can take into account the term structure of interest rates
- tax can be allowed for more appropriately
- can more easily allow explicitly for future bonuses