B2 C9 GBE2

Question 1

Describe how a life insurance company may be affected by the economic
environment in which it operates.

Answer 1

Economic environment (AAVE)
 Available asset types and their expected returns will influence insurer’s choice of investments and probability of securing return assumed when pricing.
 Consumers may see its insurance products as more or less attractive compared to other available investments.
 Volatile investment markets tend to result in more expensive insurance products and possibly less take up of them. Insurers will tend to have relatively higher capital requirements as result of increased uncertainty of investment return.
 An insurer investing in more risky/speculative markets is likely to seek
greater expected rate of return on capital and there is greater risk of the
required return not being achieved.

Question 2

Outline three main types of expenses a life insurance company may incur in
running its business.

Answer 2

Life insurance company expenses
A life insurance company may incur:
1. Commission
– initial, payable on acquisition of new policy
– renewal, payable each time renewal premium paid
2. Management expenses – incurred directly when new policies written
(new business) or maintained (in-force business)
3. Overhead expenses – incurred irrespective of new and in-force
business, eg costs of general management, property

Question 3

State the two main risks with regard to expenses.

Answer 3

Expense risks
Two main risks regarding expenses are:
1. Profitability risk – that loadings will be insufficient to meet actual
expenses incurred
2. Risk that company cannot control costs, eg due to:
 poor management
 inflation.

Question 4

Explain how legal risks may arise for an insurer.

Answer 4

Legal risks
Legal risks may arise:
 In areas of contract where insurer has discretion, eg:
– some principle related to PRE may act unfavourably to company
– unfair contract terms voiding clauses of contract.
 From developments in legal cultures, interpretations, and court
judgements (especially as insurance contracts can span many years)
 From inconsistencies between policy document and any other
representations made by company or its agents.

Question 5

State the main advantage and main disadvantages of life insurance company
regulation.

Answer 5

Regulation
Main advantage:
 Policyholder protection
Main disadvantage:
 Cost to policyholder either directly and/or indirectly (eg through reduced
innovation)

Question 6

List eight regulatory restrictions commonly imposed on life insurance
companies.

Answer 6

Regulatory restrictions can relate to: (TPRT SUBI)
1. Types of contract that can be offered
2. Premium rates or charges
3. Rating factors that can be used to calculate premiums
4. Contract terms and conditions, eg how surrender values are calculated
5. Sales channels, sales procedures or information given as part of selling
process
6. Ability to underwrite, eg prohibition on use of genetic testing or past
claims history
7. Amount of business that may be written, eg due to minimum reserving
and solvency capital requirements
8. Investments, eg types of assets allowed, whether mismatching allowed

Question 7

List the direct and indirect ways in which the regulatory framework might affect
an insurance company’s choice of investments.

Answer 7

Investment restrictions

Direct
May be restrictions on:
 types of assets company can invest in
 extent to which mismatching is allowed at all.
 amount of any type of asset that can be taken into account for solvency
purposes

Indirect
 Certain assets may allow use of higher discount rate in statutory
valuation of liabilities and so reduce value of liabilities.
 May be regulatory requirement to allow for mismatching, eg by holding
mismatching reserve (which increases with extent of investment in
riskier/volatile assets).

Question 8

State the two common methods of taxing life insurance business.

Answer 8

Taxation methods
1. Profits basis
Tax on annual profits of business, where profits means excess of
change in value of assets over change in value of liabilities
2. I – E basis
Tax payable on investment income / gains less some or all of operating
expenses of company

In addition, may be tax on premium income.

Question 9

Describe how the taxation system can influence product design and sales for
life insurance companies.

Answer 9

Tax – influence on product design and sales
1. Different types of life insurance business may be taxed differently, making it
preferable for certain benefits to be offered as one type rather than another.
2. Tax treatment of life insurance business may make it more or less attractive
as a savings medium than contracts offered by other savings institutions, subject to different fiscal regime.
3. Tax concessions to individuals make sale of certain types of contract easier.
4. Tax treatment of benefits when received by policyholders will affect sales.

Product design should make best use of opportunities provided by taxation
environment.
Taxation changes over time, which is source of risk when benefits are
guaranteed over long term.