C23 Pricing and Financing Strategy

Question 1

Define cost of benefits and price of benefits

Answer 1

Cost of benefits is the amount that should theoretically be charged for them

Price of benefits is the amount that can be charged under a particular set of market conditions
It may be more or less than the cost

Question 2

What is the formula for calculating the theoretical cost of benefits

Answer 2

Value of Future Premiums
= Value of Benefit
+ Value of Expenses
+ Contribution to Profit

Question 3

Factors to consider in calculating cost of benefits

Answer 3

Other Factors to consider in calculating cost of benefits
(Throw Crif Mulholland Off City Pier)
Tax
Commission
Margins for contingencies
Cost of any options and guarantees
Cost of the capital supporting the product
Provisioning basis
Investment income
Experience rating
Reinsurance

Question 4

How are the cost of establishing provisions and solvency capital allowed for in calculating the cost of financial products?

Answer 4

The cost of establishing provisions and solvency capital - should be included as a negative cashflow during the term of the contract
+ any prudent margins in the provisions and the explicit solvency capital should be released as a positive cashflow when the contract terminates

Question 5

how are profit testing models used in pricing?

Answer 5

• Profit testing models can be used to estimate the results of providing the product under different scenarios
• Deterministic scenario or stochastic simulation (depending on risk exposure and the cost/benefit analysis of the modelling approach
• The provider will need to determine a minimum level of profit e.g. a profit of x% of premium is exceeded in 95% of simulations
• Market testing : Factor a premium criterion into the premium or Input the desired premium into the pricing model and calculate the resultant profit

Question 6

Financing options of benefit schemes

Answer 6

Unfunded:
Pay-as-you-go, benefits met out of current revenue.

Funded:
- Lump sum in advance (lump sum when benefit is promised)
- Terminal funding (lump sum when benefit first becomes payable)
- Regular contributions (gradual build-up of fund before benefit payment)
- Just-in-time funding (only in response to an external risk event and then pay-as-you-go, or terminal funding once the benefit comes into payment)
- Smoothed pay-as-you-go (pay-as-you-go but with a small fund to ease administration and liquidity)

Question 7

Why the premium/price may differ from the cost?

Answer 7

DULL:
Distribution / Elasticity: Provider’s distribution system for the product may enable them to sell above the market price or to take advantage of economies of scale and reduce the premiums charged

U/W: may only be a limited number of providers in the market and so higher premiums can be charged. Alternatively, if there are lots of providers in the market premiums will fall.

Loss Leader: cheaper product may attract customers to other, more profitable products of the company.

Question 8

Why actual contribution rate may differ from theoretical cost of benefits?

Answer 8

• Scheme may be in deficit and contribution rate may have to be increased to eliminate the deficit
• Scheme may be in surplus and the contribution rate may be reduced to eliminate the surplus
• Sponsor may want to alter the pace of funding by paying a higher or lower contribution in any year. Legislation may restrict the extent to which this can be carried out.