CH 15 (WM) Flashcards
Describe the various sources of data for setting lapse assumptions. [ ]
Lapse rates will be based on an analysis of the company’s recent experience. Ideally, this should relate to the contract being priced, but if no such experience exists or the available data are inadequate, then the experience under any similar contracts would be analysed.
If the company does not have adequate own data, there may be industry-wide experience that it could use.
Market data sources are altogether much less useful for estimating lapse rate experience than is the case for other demographic assumptions.
Reinsurers may also be a source of lapse rate data, however, there will be no population data that can be relevant to lapse experience.
State the reasons why market data are less useful in predicting lapse rates. [ ]
The reasons why market data are less useful in predicting lapse rate experience include: ●
lapse rates are generally much more unpredictable than other demographic experience rates because they are dependent on human choice (which may be influenced by economic, political and commercial factors as well as general awareness)
●
there is much more heterogeneity in lapse rate experience between companies, reflecting differences in distribution channel, target market, product design, benefits provided etc, so the data will be less relevant
●
past data and future experience are both influenced by changes to the economic environment, the level of market competition and the standards of customer service; these are all very difficult to allow for and to predict
State two factors that a company’s own set of lapse rates will be highly dependent on. [0.5]
distribution methods
after-sales service
State two factors that may affect adjustments to the historical rates when setting the future lapse assumptions. [0.5]
The level of economic confidence and the ongoing competitiveness of the product
How would you expect a deterioration of the economic situation to affect lapse rates for the following non-linked regular premium contracts:
(i) stand-alone CI insurance (ii) pre-funded LTCI (iii) PMI
The two things to consider in a scenario of economic deterioration are: ●
● (i)
whether people can still afford to keep the policy going, and whether they would get any cash from surrendering the policy.
Stand-alone CI insurance
The premiums are fairly low so there should be very few policyholders who now find themselves unable to continue paying premiums.
There is almost certainly no surrender value available, so there is no incentive to surrender.
So you would not expect the economic downturn to affect lapse rates materially for this contract.
(ii) Pre-funded LTCI
The premiums are probably a non-trivial portion of policyholders’ incomes. Some policyholders will now be unable to pay these premiums.
Some LTCI policies offer some compensation on discontinuance after the first few years, though usually as paid-up policy benefits.
So you would expect an increase in discontinuance rates. (iii) PMI
PMI contracts technically terminate at the end of each policy year, so no surrender value is payable – indeed the notion of a “surrender” for a PMI contract has no meaning. Policyholders simply have to decide whether or not to renew their policies each year.
PMI premiums can be quite expensive, so some policyholders will no longer be able to afford them.
So it is very likely that lapse rates – ie non-renewal rates – will increase
List the subdivisions of data that you might use in order to analyse the lapse rate experience of own company data, for CI policies.
Possible subdivisions include: ●
● ● ● ● ● ● ● ● ● ● ● policy type (eg stand alone, claim acceleration)
different series (eg issued in different past years with different policy wordings) sales channel
sales agent
policy duration premium size
benefit size
premium payment frequency (annual / monthly) premium payment method (cheque / direct debit) age
gender smoker status.
Srate the factors that influence the policyholders’ decisions to lapse.
So we need to think about the factors that influence the policyholders’ decisions to lapse. These factors can be: ●
● ● ●
economic (can the person continue to afford the premium?) political (what State benefits are offered as an alternative?) commercial (is there a better or cheaper competitor’s product?) awareness (is there a belief that the policy is necessary?)
Question 15.13
List the factors that might make future renewal experience different from the past, for PMI policies. [ ]
The factors that might make future PMI lapse rates change in future include changes in: ●
● ● ● ● ● ● ● ● ● ● ● ● ●
economic conditions, especially those affecting employment availability of, or the level of, State healthcare benefits
distribution channel sales methods
target market territory
product design policy wording benefits provided
underwriting practice claims-handling practice price
competitiveness standards of customer service.
How might a change of distribution channel affect lapse rates?
Solution 15.14
A change in who initiates the sale can affect lapse rates (lapse rates are likely to be lower if the client initiates the sale).
The sales practice may be different, for example, where clients have been put under more sales pressure to buy a policy, or to take a larger policy, then lapse rates are likely to be higher than where sales have been more strictly based on need. This might particularly be the case where the intermediary’s rewards are largely based on initial commissions, rather than renewal or level commissions.
Sales of policies made without proper information being gathered about the client’s needs, can lead to inappropriate policies being sold through ignorance (though this is again a reflection of poor sales practice).
Different levels of financial sophistication of the client base can lead to different perceptions of the value of a contract, and could lead to different lapse rates.
Different target markets may encompass different levels of affluence and economic prosperity. There may then be differences in withdrawals that arise through economic hardship.
The effect of lapses
The effect of lapses
Lapses affect the contract in a number of ways: ●
Firstly, an early lapse may cause financial loss, where insufficient premiums have been received to recover the initial strain (commission and initial expense) involved in writing the policy.
Secondly, where no surrender value is payable and a reserve has been accumulated, a lapse will work to the benefit of the insurer.
Thirdly, at any time, the effect of lapses may be selective, such that the healthier lives will be more likely to lapse, leaving a worsening propensity to claim among those continuing.
For policies that pay indemnity benefits, the above will mean that the continuing policies will generally be those that incur larger, as well as more frequent, claims.
For example, PMI lapse rates are also heavily correlated with claims experience – generally the lowest claiming members have lapse rates that are significantly higher than the rate of the highest claiming members, since the latter will find it more difficult to obtain similar insurance cover with another insurer and are likely to value the benefits of the product more highly.
Explain the problem of lapse and re-entry, and why this is a particular problem in the conditions described in this tuition material.
Lapse and re-entry is where policyholders find they would be better off lapsing their current policies and taking out new ones. (This is only really an issue for long-term policies such as CI and LTCI, because the “lapse and re-entry” of a short-term policy would essentially be the same as an ordinary policy renewal, but with more underwriting involved – so no-one would bother.)
This will be a problem when premium rates are falling, so that even though a lapsing policyholder is older than when his/her premiums were originally calculated, the premium rate for a new policy at the current age is still cheaper.
State the principles that should be taken into account when setting the demographic assumptions in the pricing basis for a new healthcare insurance product.
[5]
lives who will take out the contract.
[1⁄2]
In particular consideration should be given to: ●
● ● ●
the target market and distribution channel the territory in which the product will be sold the underwriting controls
[1⁄2] [1⁄2] [1⁄2]
the expected changes in morbidity between the time of the last experience investigation and the average point in time at which the demographic assumptions will apply.
[1⁄2]
The assumptions will be based on an adjustment to rates from a standard table, if an appropriate table is available.
[1⁄2] [1⁄2]
The adjustment could be derived by analysing the company’s experience for a similar class of business, if there is one.
The period of the investigation should be long enough so that the volume of data (exposed to risk) is large enough, but not so long as to introduce excessive heterogeneity into the data, due to trends in experience over time.
[1⁄2]
Split the data into homogeneous groups to reflect the rating factors, subject to a credible level of data in each cell.
[1⁄2]
If insufficient data are available from the company’s experience, then external data should be used instead:
… eg industry, reinsurers’ or population data. [1⁄2]
Further adjustments may be required to allow for changing or differing target markets, policy wordings or underwriting procedures.
[1⁄2]
If there is great uncertainty surrounding the correct rates to use then significant margins will be needed and a prudent assumption used, or alternatively may use a higher risk discount rate for valuing the profit flows.
[1⁄2] [Maximum 5]
Question X3.1
(i) Explain why it is important to incorporate persistency rates into product pricing. [4]
(i)
Why persistency rates are an important component of product pricing Long-term contracts
If a health and care insurance company pays a benefit upon surrender that is higher than asset share, the company will make a loss on that individual policy.
[1⁄2] [1⁄2]
The same will happen on policies that pay no surrender benefit where asset shares are negative …
… which will normally be true at early policy durations when withdrawal rates also tend to be highest.
[1⁄2]
Similarly, paying a benefit which is less than asset share will give rise to a profit. [1⁄2] Persistency is also important for projecting future in-force volumes.
higher withdrawal rates would mean that less profit would be expected from the portfolio later in the policy term, as fewer policies would still be in force.
Short-term contracts
Renewal rates are needed in order to assess the extent to which initial expenses can be spread over subsequent renewals.
[1⁄2]
The lower the renewal rate, the fewer renewals are expected from each policy sold, and so the higher the premium loading for initial expenses needs to be.
[1⁄2] All types
The impact on volume will affect the spreading of overhead expenses, and also of any fixed one-off expenses such as those for product development.
[1⁄2]
Poor withdrawal rates may also lead to reduced profits as a result of excessive levels of commission being paid, eg if indemnity commission is used.
[1⁄2]
This will be less of an issue if appropriate commission clawback arrangements are in place.
[1⁄2]
Withdrawals can be selective, taking out the healthy individuals from the portfolio and leaving the remaining policies subject to higher claim experience than was originally expected.
[1⁄2]
The pricing morbidity assumptions must take account of the expected effect of these selective withdrawals.
[1⁄2]
If persistency is incorrectly allowed for in the company’s pricing models, this would give a misleading indication of the profitability of the contract.
This could also affect competitiveness and hence sales volumes.
It has been suggested that, rather than analysing its own experience, a health and care insurance company should use industry statistics to estimate persistency rates appropriate for pricing future product launches.
(ii) State reasons why this suggestion may be inappropriate. [3]
Why is the suggestion inappropriate?
The company will not have the same experience as the industry average, due to differences in such things as: ●
● ● ● ● ● ●
sales method and distribution channel target market
products or product features
level of any surrender values paid quality of after-sales service relative competitiveness company reputation.
[1⁄2] [Maximum 4] [1⁄2] [1⁄4 each, ,maximum 11⁄2]
Industry data will be a heterogeneous mix of the above factors, and the great variation in withdrawal experience between the different companies will make the industry average a very poor indicator of the level of withdrawals for any individual company.
[1⁄2]
Also, industry statistics may be wrong, unavailable, out of date or not presented in sufficient detail.
[1⁄2]
The effect of heterogeneity in the industry data can also give rise to spurious trends in experience observed over time, through changes in the mix of companies that comprise the industry statistics.
[1⁄2] [Total 3]
