Ch 17: Actuarial Funding

Question 1

Why actuarial funding is used

Answer 1

• A large net loss will be suffered on each policy at inception as the initial costs outwheigh any initial charges and initial unallocated premium. This will need to be paid for out of capital.
• In the past high initial costs were recouped by varying the allocation percentage, with lower % in early years. Not consisetnt with policyholder expectations

Question 2

Aim of acuarial funding

Answer 2

• Actuarial funding is a technique whereby insurance companies can hold lower reserves for unit-linked contracts to which it can be applies, and thus can reduce new business strain.
• Company holds smaler unit fund at policy inception than would be expected to be bouht for the given amount of premium.
• The money “saved” is used to cover initial expenses.
• The “missing” funds are then bought later on from the future management charges.
• The fund management charge thus needs to be greater than that necessary to cover actual fund management expenses.
• So in effect: Company is taking credit at inception for some of the future charges by allocating less money to the PHs unit account at inception.

Question 3

Condition for actuarial funding

Answer 3

• For actuarial funding to be workable therefore need a charging structure that has higher than “normal” levels of regular fund management charges
• This can be done in two ways:
  * Different management charges on “capital” and “accumulation” units.
  * Higher management charge on all units.

Question 4

Explain the workings of capital vs accumulaton units in actuarial funding context.

Answer 4

• Capital unit attract a higher fund management charge than accumulation units.
• During first few years allocated premiums would be used to buy capital units, subsequently accumulation units will be bought.
• No longer popular as there is trancparency issue with customers

Question 5

Why is actuarial funding okay?

Answer 5

• Usually the unit fund is fully funded in the sense that investments are held which exactly match the value of the units purchased by allocated premiums.
• However the unit fund will only be required when a certain contingent event occurs.
• On this event the unit fund + additional payment from non-unit fund (if applicable) is needed.
• Because the liabilities are contingent then it is reasonable to hold the actuarial present value of the unit fund rather than its fully funded value.

Question 6

Discount rate for Actuarial Funding Factor

Answer 6

• Max = fund management charge
• Should be the proportion of the charge we want to take advance credit for.
• The main consideration will be the ability of the company to cover its ongoing renewal expenses using the management charge on all units.