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

FREED PPL

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

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
2. Available asset types/expected returns
   
   • influence insurer’s investment choice and
   • probability of securing the return assumed when pricing
3. Volatile investment markets usually => 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
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

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

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
  • Direct:
    
    • incurred directly for new business written/maintain existing business
    • fixed: stable in short term, doesn’t change with busines written
    • variable: change with volumes of business written
• Expenses influence by
  
  • wage/salary levels
  • general levels of prices
  • prices of specific commodities

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

Explain how legal risks may arise for an insurer (5)

Answer 5

1. PRE
   
   • some principle of acting unfavourably to insurer
   • e.g flexibility in bonus method being constrained
   • legally required to distribute profits in way that is kept consistent with PR
2. Unfair terms voiding contract
   
   • Product design should not incorporate features that are considered unfair
   • e.g. if particular charge reviews by fixed rate, say, specified in contract seen as unlawful
   • risk of ability to review charges being removed
3. New legislation over time
   
   • that could change legal contract between insurer and existing policyholders
4. Misrepresentation
   
   • inconsistency in policy documents and other relevant representations made by company or its agents
5. Insurance contracts spanning several years
   
   • hence open to developing legal cultures, interpretations, court judgements

Question 6

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 (reduced innovation/benefit levels)

Question 7

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. Ability to underwrite e.g. prohibition on use of generic testing/past claims history
4. Rating factors that can be used to calcualte premiums
5. 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 e.g. types of assets allowed whether mismatching allowed

Question 8

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 allow for mismatching reserve

Question 9

Briefly describe 2 common ways of taxing life insurance business

(1,4)

(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. Focuses on shareholder profit
     
     1. profit distributed to WP policyholders automatically excluded from profit calc, since they would increase reserves and reduce assets
• 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 10

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 (6)

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 guaranteed over long term
   
   • existing policies not immune from effects of changes
   • company risks making less profits that anticipated in pricing (increased tax bill)
   • may render profitable/attractive products as unprofitable/unattractive
   • products may have to be redesigned or even scrapped —> causing additional expenses
   • could cause an increase in withdrawals and all the problems that come with that
   • change to methods of accounting for/collecting tax might increase the company’s expenses and reduce profits

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, as the standards can support the advice given
3. Guide interpretation of governemtn regs if gov doesn’t want to be overly prescriptive
4. Adds safeguards
5. Ensures consistency
6. Certain standard
7. Generate consumer confidence