Ch 17: Actuarial funding Flashcards
1
Q
What is actuarial funding? (4)
A
- In the context of unit linked contracts, acturial funding is when the insurer takes credit for some of the extra future annual management charges in present day’s terms.
- Life insurers can hold lower reserves for unit-linked contracts to which it can be applied, and this reduce new business strain
- Money saved can be used to cover intitial expenses.
- Missing unit funds then bought later on from future management charges and management charge should thus be greater than the actual fund management expenses.
2
Q
What are the requirements necessary for actuarial funding to work? (5)
A
- Permitted by regs
-
Benefit contingent on death/survival
- for minimum period of years, thus still some risk on death
-
Unit related charge
- company hold less than full funded value
- additional units purchased over lifetime (using unit related charges)
- unit charge exactly sufficient (because charge is unit related, irrespective of any price movement)
-
Sufficient regular fund management charges
- limiting condition is that after actuarial funding, prudently projected future net cashflow to insurer remain positive
- shortfall capitalised in non-unit reserve
-
Unit-linked related surrender penalty
- imposed such that unit reserve not lower than surrender value payable
3
Q
What common mechanisms can be used to implement actuarial funding? (2)
A
-
Higher fund managment charges
- on all units
- need sizeable quanity of fund management charges to pre fund
- Capital/accumulation units (with different management charges)
- capital units: attracts higher managment charge, typically allocated premiums used to buy during first few years
- accumulation units: lower management charge, allocated premiums used to buy later on
- however, has issues with transparency:
- thus no longer really used in contract design
- but because of long term nature, still many policies in force
4
Q
Actuarial funding factors
A
For endowment assurance at policy duration t allowing for contingency of death would be (using a suitably chosen basis):
- UFt * A(x+t:n-t), where
- UFt is the fully funded value of the unit fund at policy duration t
- x is the entry age
- n is the policy term
- Discount rate used should be proportion of fund management charge we wish to take advance credit for
- considering the ability to cover renewal expenses
5
Q
What is the effect of actuarial funding on net cashflows from the unit fund? (5)
A
-
Creates extra cashflows to non-unit fund (funding factor)
- to help reduce new business strains
- net cashflow reduces since assurance factor increases with time
-
Reduces future managment charges
- transferred from unit fund to non-unit fund, coz charge is only levied on actual number of units purchase (which will now be less)
-
Additional charges/reduced credits
- to non-unit fund will be much smaller than the additional credit as result of actuarial funding, providing AMC on units in unit fund is substantial
-
Creates additional liability on death
- on non-unit fund, coz death of policyholder because higher amount required to make up bid value of unit fund to guaranteed minimum sum assured
- this expected additional death cost is a charge on non-unit fund at each year end
-
Swap high future managment charges for capitalised sum early
- thus matched cashflows from policy with incidence of expenses
6
Q
Considerations to consider when applying actuarial funding? (2)
A
-
Don’t allow excess management charges
- In the calculation of non-unit reserves
- only residual cashflows from unit fund can be counted towards future cashflow projections
- full fund management charge is no longer available for this purpose
- Unit fund should not be less than surrender value
- thus, extent to which actuarial funding may be employed is restricted by amount of any surrender penalty (reduction in benefit from bid value of units) that company may impose.
- too risky to deduct cost of additional benefit on surrender, coz surrender is policy option, it is quite feasible for all policies to surrender over a very short period of time.
- would then have to find value of units almost immediately, and there’d be inadequate reserves
7
Q
Advantages of actuarial funding? (7)
A
- Lower reserves
- Reduce new business strain
- Write more new business
- More capital effecient
- Charges/expenses well-matched, while also…
- …allowing initial allocation (insted of zero allocation to match charges/expenses)
- making product more marketable than if allocation was zero
- Reduced investment/persistency risk
- because charges/expenses more closely matched
8
Q
Disdvantages of actuarial funding? (5)
A
- Regulatory restrictions
- Can be complicated
- particularly when used together with capital units
- Issues because of complexity
- reduced transparency
- poor persistency because of selling to clients who don’t understand
- restricts distribution channels
- more effort required to sell
- may restrict level of sales, depending on remuneration
- Requires surrender penalty
- which may be unattractive
- Increase mortality risk
- As sum at risk will be higher due to greater discrepency between reserves held and face value of units
9
Q
Summary
A
- Flows from unit fund to non-unit fund
- Actuarially funded units cashflow of unit management charges from the unit fund to the non-unit fund will be adjusted. Calculated by (for first two points):
- UF(t-1) * F(t-1) * (1+g) - UF(t) * F(t)
- where UF(.) is the face value of units at .
- F(.) is the actuarial funding factor at .
- g is the unit growth over the year
- difference between fully and actuarially funded units
- cashflow from unit fund to non-unit fund on each unit purchased
- charge on units
- cashflow from unit fund to non-unit fund, followed at same time by cashflow from non-unit fund to unit fund to build up inreasing number of actuarially funded capital units required at year-end
- excess of value of units (actually held by company over surrender value granted)
-
Flows from non-unit fund to unit fund
- cost of excess guaranteed minimum sum assured on death
- over the value of units actuallyp held by company
- cost of excess guaranteed minimum sum assured on death