Ch 21: Pricing (3) Considerations for office premium

Question 1

Factors to consider before deciding on a final price

Answer 1

• Profit criteria that might be used
• Marketability
• Competitors
• Impact of reserving and solvency capital requirement on the final premium
• Reinsurance
• Regulations

Question 2

Advantages and disadvantages of NPV

Answer 2

Disadvantages:
* Subject to law of diminishing returns, i..e can’t sell the same contract an unlimeted amount of times
* Says nothing about competition, no point in designing contract with high NPV if it cannot be sold.
* Can only be compared with another contract if appropriate risk discount rate was used for both
* Assumes that there is a perfectly free and efficient capital market
* Useless by itself should be combined with some measuring standard (i.e express it in terms of selling effort (i.e. commission)

Advantages:
* Can be combined with other metrics to give a useful standard measure

Question 3

IRR disadvantages

Answer 3

• Does not always agree with the NPV
• If more than one change of sign features in the stream of profits there may not be a unique IRR
• BPV can be related to useful indicators of the policy’s worth to the company, no way to do this with IRR
• If policy makes profit from outset, IRR may not exist

Question 4

Premiums charged need to be considered for marketability, which may lead to a reconsideration of:

Answer 4

• Design of the product (remove risky features or include innovative features to differentiate itself)
• Distribution channel used (if it willl permit either revision of assumptions used ot higher premiums without loss of marketability)
• Company’s profit requirement
• Whether to proceed with marketing the product
• Re-examination of assumed expenses involved (req expense contribution to fixed overheads, commission…)

Question 5

Impact of competitor pricing on insurer depends on

Answer 5

• Market structure
• Sales channel
• Features of the product
• Availability of comparison quotes
• Other features of the market

Question 6

Pricing should allow fo cost of capital. To accurately model cost of capital:

Answer 6

• Reserves should be included in the pricing model calculated using realistic assumptions (i.e, assumptions that would be used in future as determined by regulations)
• The risk discount rate shoudl allow for returns required by shareholders on the capital they have invested.

Question 7

How reinsurance can lower solvency capital requirements

Answer 7

• Pure reinsurers may have a lower solvency capital requirement than the direct writer, so the higher the proportion reinsured, the lower the solvency capital required (total capital required by both insurer and reinsurer is reduced)