Ch 2: LIP 2

Question 1

Risks facing insurer with a whole life policy

Answer 1

• Investment risk
• Mortality risk (the relative and absolute significance of these risks depend on age at entry and duration in force of the contract)
• Selective withdrawals increases mortality risk
• Expense risk - long durations increased exposure to inflation
  *

Question 2

How to combat effect of inflation on expense risk for level premium paying contracts

Answer 2

• Policies written such that premium payments cease at some age (example 80)

Question 3

Needs of the consumer met by Term Assurance

Answer 3

• Protection against financial loss for dependants at lower cost for same level of benefit

• Decreasing term assurance used to pay balance outstanding on a repayment loan and used as an income for family untill such time that they can fend for themselves.

Partnership could use policy to provide protection against financial loss that might occut on the death of a key person within the organisation

Credit card company could use product to provide benefit on death equal to balance outstanding on a credit card

Employers can use group version of the product to provide benefit to employee’s dependants on death whilst in employment

Question 4

Withdrawal risk is greater under decreasing term assurance contract, why

Answer 4

• If level pemiums are payable through out the term of the policy then it is quite likely the cost of the benefits payable on death in the early years would exceed the pemiums payable, later on the premiums would exceed the cost of the benefits and these would in theory make good the earlier shortfalls
• Effect of producing a negative asset share for a significant part of the term of the policy, which means many more opportunities for a loss to occur on withdrawal.

• Further factor that makes the financial withdrawal risk much greater: As the policy progresses the sum assured reduces, and the policyholder has less and less of an incentive to keep paying premiums. There might even be a point where the policyhlder would be better of lapsing the policy and taking out a new level term assurance for the same premium for the rest of the term - could en up with a higher level of cover by doing so. Thus a financial incentive to withdraw.

Limiting the period over which premiums are payable reduces the two aspects of the withdrawal risk, since the asset share would become positive earlier in the policy term and and it removes the financial incentive to withdraw.

Question 5

Needs of renewable or convertable ter assurance

Answer 5

For individuals, these contracts combine the attractions of a term assurance, in terms of obtaining low-cost death cover, with the certainty of being able either to convert to a permanent form of contract, ie an endowment or whole life assurance, when it can be afforded or to renew the original contract for a further period of years, all without health evidence being provided (unless the benefit level is increased).