Ch 12: General business environment, 2

Question 1

List the factors in the general business environment which affect a life insurer’s business (8)

Another useful acronym from CA1/ARM

(CREATE GREAT LISTS)

Answer 1

DERLF PEP

1. Distribution channels used and their impact
2. Economic environment
3. Regulatory contraints/opportunities
4. Legal environment
5. Fiscal regime
6. ropensity of consumers to purchase products
7. Expenses and commission
8. Professional guidance

Useful CA/ARM list for the external environment within which insurer’s operate

• Competition & the underwriting Cycle
• Regulation
• Environmental & Ethical considerations
• Accounting standards
• Tax
• Economics (interest rates, inflation, economic growth, exchange rates)
• Governance (corporate)
• Risk management (operational, credit, market)
• Experience from overseas
• Adequacy of capital and solvency requirements
• Trends (demographics
• Lifestyle
• International practice
• Social trends
• Technological changes
• State benefits

Question 2

Describe how an insurer may be affected by the economic environment in which it operates.

(4)

Answer 2

1. Consumers may see insurance products as more/less attractive based on state of economy
2. Available asset types/expected returns
   
   • affect insurer’s investment choice and
   • prob of securing pricing return assumed
3. Volatile investment markets usually => more expensive insurance prods and possibly less take up of them.
   
   • Insurers will tend to have relatively higher capital requirements as result of increased uncertainty of investment return
4. Insurer investing in more risky/speculative markets is likely to seek greater expected return on capital and there’s greater risk of required return not being achieved.

Question 3

Outline Expenses and Comm

• main types of expenses an insurer may incur in running business and (6)
• what they are influenced by (3)
• NUB vs Renewal costs (5)

Answer 3

• Commission
  
  • initial, payable on acquisition of new policy
  • renewal, payable on premium renewal
• Management expenses
  
  • Indirect
    
    • overheads: incurred irrespective of new/in-force business e.g. costs of general management, property
    • fixed
  • Direct:
    
    • incurred directly for new business written/maintain existing business
    • stable in short term
    • variable: change with volumes of business written
• Expenses influenced by
  
  • wage/salary inflation
  • retail price index
  • prices of specific commodities
• NUB is cyclical = > costs are also cyclical
• Renewal costs more predictable
• Use duration of policy to det change in costs:
  
  • eg 20 year term => NUB vol diluted 20% vs in-force business
  • policies issued in last 19 years unaffected by NUB vol issued in last year

Question 4

State 2 main risks with regard to expenses

Answer 4

• Profitability risk
  
  • loadings insufficient to meet actual expenses incurred
• Risk that company cannot control costs
  
  • poor management
  • inflation

Question 5

Legal environment

Explain how legal risks may arise for an insurer (6)

Answer 5

1. Legal environment needs to be stable and effective. To avoid legal risk.
2. Care taken around sections of insurer discretion:
   
   • PRE taken into account
   • e.g diff bonuses to diff PH
   • TCF, to avoid legal battles
3. Unfair terms voiding contracts
   
   • reviewable charges being restricted by law and PRE
4. New legislation over time
   
   • that could change legal contract betwen insurer and existing policyholders
5. Misprepresentation of wording
   
   • inconsistency in policy documents and other relevant representations made by company or its agents
6. Insurance contracts spanning several years
   
   • hence open to developing legal cultures, interpretations, court judgements

Question 6

Regulatory constraints

State main advantages and main disadvantages of life insurance company regulation

(1,4)

(1,2)

Answer 6

1. Main advantages:
   
   • protection of policyholder interests
   • companies don’t always manage affairs properly
   • large sums of money over long term
   • public need confidence
2. Main disadvantages
   
   • Cost to policyholder either directly and/or indirectly e.g. through reduced innovation
   • Impacts contract design

A311 ICCSC

Question 7

Regulatory constraints

List 8 regulatory restrictions commonly imposed on life insurance companies

Answer 7

1. Types of contract that can be offered
2. Contract terms and conditions e.g. how surrender values are calculated
3. Underwriting e.g. prohibition on use of generic testing/past claims history
4. Rating factors that can be used to calcualte premiums
5. Min/Max Premium rates/charges
6. Sales channels/sales procedures or info given during sale
7. Amount of business that maybe written (indirectly) e.g. due to minimum reserving/solvency capital requirements
8. Investments limited e.g. types of assets allowed whether mismatching allowed

Question 8

Regulatory constraints

List direct and indirect ways in which regulatory framework might affect insurer’s choice of investments

(1,3)

(1,2)

Answer 8

• Direct, restrictions on
  
  • types of assets company can invest in
  • amount of any particular asset admissable for solvency
  • extent to which mismatching is allowed at all
• 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 allwo for mismatching reserve

A311

Question 9

Fiscal regime

Briefly describe 2 common ways of taxing life insurance business

(1,6)

(1,1)

(1,1)

Answer 9

• Profits basis
  
  1. Tax on annual profits of business, where profits means excess of change in value of assets over change in value of liabilities
  2. Reserves used will generally be supervisory basis, because limit’s company’s ability to manipulate reserve amt, hence taxable profit
  3. Reserves should be prudent as profit is being released.
  4. Focuses on shareholder profit
     
     1. profit distributed to WP policyholders automatically excluded from profit calc, since they would increase reserves and reduce assets
• Profit=(A1-A0)-(L1-L0) or change in free assets= (A1-V1) - (A0-V0)
• I - E basis
  
  • Tax payable on investment income/gains less some or all of operating expenses of company
  • • tax on premium income

Question 10

Effect of fiscal regime

Describe how taxation system can influence product design and sales for life insurance company

For policyholder (1,2)

For insurer: current implications (3,1)

For insurer: future implications (2)

Answer 10

For policyholder

1. Tax treatment in policyholder’s hands can influence buying habits, and attractiveness of life insurance
   
   • tax treatment of premiums paid
     
     • particulalry when premiums are deductible from individual’s taxable income in part/full/not at all.
   • tax treatment of eventual policy benefits

For insurer: current tax implications

1. Product design make use of opportunities offered
   
   • ability to maximise favourable taxation treatment may force constraints on product design
2. Tax concessions helps ease sales of certain contract types easier
3. Tax treatment impacts life insurance attractiveness
   
   • tax treatment of insurer’s funds

For insurer: future tax implications

1. Taxation risk from changes over time, important to bear in mind when benefits gauranteed over long term
   
   • existing policies not immune from effects of changes
   • company risks making less profits that anticipated in pricing

Question 11

Briefly discuss the impact of professional guidance on products which life insurers choose to sell

(1,2)

(1,6)

Answer 11

1. Actuarial associations often issue professional guidance for actuaries advising life insurers
   
   • give framework to consider when carrying out resposibilities to maintain professional standards
   • necessity thereof depends on extent that legislation limits actuary’s judgement
2. Helps to not restrict actions of actuary eg colvency concern
3. Guide interpretation of government regs if gov doesn’t want to be overly prescriptive
4. Adds safeguards for porper running of insurers
5. Ensures consistency
6. Certain standard
7. Generate consumer confidence

Question 12

Regulatory constraints

Wider regulatory environment 4 and Climate change 6

Answer 12

• Limit institutions that can sell insurance
• Prevent monopoly
• Banks and other instit subj to diff regs
• Change design to take advantage of regulatory opp
• Climate change:
  
  • A311
  • Concern about damage and improvements that can be made
  • Consider climate risks in bus plan, invest man, risk man
  • Disclose, report climate risks and opportunities
  • Consistent reliable assessment, pricing, managing risk
  • Voluntary actions atm