Ch 23: Contract design Flashcards
List the 7 key parties involved in contract design
Actuaries
* Initial pricing
* Determine reserves and design process
Lawyers
* Draft contract ensure no extra benefits provided
Providers of benefits
* Want contract that meet their needs in cost effective way
* Providers needs influenced by: Market,capital,liquidity,expertise
Accountants
* Ensure income.outgo accounted for correctly
Customers
* Customers needs influenced by: premiums,risks covered,risk appetite
Administrators
* Ensure contract is administered
Shareholders / financial backers
* want reports on how finance is being used
ALPACAS
List 18 factors to consider when designing or redesigning a contract
Administration systems Marketability Profitability Level and form of benefits Early leavers benefits
Discretionary benefits Interests and needs of customers Risk appetite of the parties involved Expenses vs charges Competition Terms and conditions of the contract
Financing (capital requirements) Accounting implications Consistency with other products Timing of contributions or premiums Options and guarantees Regulatory requirements Subsidies (cross-)
AMPLE DIRECT FACTORS
List the factors influencing the needs of the provider
3
- The chosen market
- The capital available
- The expertise available
List the factors influencing the needs of the customer
4
- The capacity to pay
- The risks they need to be covered
- The benefits that are needed at different times in the future
- Attitude to financial risk
Give examples of how a contract can be designed to cater for different risk appetites amongst customers
2
- Different investment funds , e.g. low, medium and high risk
- Different levels of cover, e.g. comprehensive vs third party
Give examples of how the regulatory environment may influence the design of a product
4
- Products must meet regulatory requirements.
- Products can be designed to benefit from favorable financial or taxation regimes.
- Products should be designed to ensure that initial expense can be recouped if a policy is cancelled within any regulatory ‘cooling-off’ period. Otherwise make loss on initial expenses
- Regulation may require information to be disclosed to potential customers, for example discontinuance terms.
TCF:
* Ensure fair treatment of customers across the entire product life cycle
* Design,pricing,promotion,advice and servicing.claims processing,complaints management
Give the variables that influence profitability of a contract
5
- Claims experience: Mort. morb, freq,severity
- Expenses and inflation
- Investment returns
- Withdrawal experience
- NUB sale volumes and mix
Give examples of contract design features that make a contract more marketable
4,3
- Guarantees, options and choices
- A competitive (low) price
- Transparency and simple to understand
- Features that distinguish it from the competitors
- Target market changes design
- lower income: simple features reduce cost and incr understanding
- higher income: more coomplex products that change with circumstances.
Give the competitive factors that need to be considered in contract design
2
- Price
Lowest price price = higher volumes, so design to cover basic needs to keep costs down as easily comparable - Product features
Compared on features available. Can recieve selective business/ innovate with unseen features
State the Level and form of benefits offered
3
- Amount covered
- Regular payment/ One-off benefit
- Vary with customer needs and cost of contributions
Options and Guarantees
2
- Options
One party has choice and other sets terms
eg WOP option: stop premiums and change level of benefits
eg change level of premiums and renewal options - Guarantees
eg Basic sum assured is guaranteed to increase with inflation. Minimum maturity values
List examples of guarantees that might be offered as part of a contract design
6
- Guaranteed benefits
- Guaranteed minimum maturity value
- Guaranteed minimum growth rate
- Guaranteed annuity rates
- Guaranteed premiums
- Guaranteed charges
Discretionary benefits
3
- Surplus is shared with policyholders
- Can be through:
With profits
No claim discounts/bonuses
Reduction in premiums - Main consideration is PH resonable expectations
Discontinuance benefits
1,4
- Benefit provided on voluntarily stopping premiums
Can be provided on:
* Surrender: The policy stops, there is no further cover and the policyholder receives a lump sum payment SV
- Lapse: The policy stops, there is no further cover and usually no payment is made to the policyholder
- Paid-up: The policyholder ceases to pay premiums but the policy continues to offer the policyholder some cover. Benefit reduced to paid up value
- Withdrawal:This normally encompasses surrender and lapse, as the policy does not stay in force.
Factors to consider when determining discontinuance terms
6
Fairness, hence the starting point will be the ‘asset share’ of the contract (a current value determined retrospectively from the accumulation of net cashflows)
Other factors include:
- PRE
- New business disclosure and any subsequent communications
- competition
- regulation / legislation affecting discontinuance terms
- administration expenses of determining and implementing the terms
- ease of calculation and frequency of change of terms
Main factors to consider in determining suitable discontinuance terms for an individual leaving a benefit scheme
6
- Fairness between the leaving member and those staying
- Whether the member want to stay in the scheme as a deferred member or take a transfer value to another scheme
- The scheme’s funding level at the point of discontinuance
- Regulation / legislation affecting discontinuance terms
- Administration expenses of determining and implementing the terms
- Ease of calculation and frequency of change if terms
Define ‘new business strain’
3
- New business strain is the shortfall that occurs when a contract is written.
- It occurs when the initial expenses, the provisions and any solvency capital exceed the premium received.
- New business strain results in a initial capital requirement (to finance the shortfall)
List ways in which a contract could be designed in order to reduce new business strain
5
- Avoid options and guarantees
- Match charges with expenses, and keep charges variable.
- Low initial expenses / commission
- Offer contracts with low statutory provisioning requirements.
- Use single premiums rather than regular premiums
List four methods of financing benefits
4
- Pay as you go
- Funding all the benefits in advance (single premium)
- Regular payments building up a fund
- Paying an amount when the benefit even happens, for example purchasing an annuity at the point of retirement
Outline the main administrative considerations that relate to contract design
5
These include:
1. whether to outsource the administration or perform it in-house
- whether existing systems can carry out the functions that have been built into the product design
- the need to produce a new or updated product literature
- the cost of making systems and admin process changes
- whether some of the changes can be deferred because they are not required at short policy durations - whilst bearing in mind the potential difficulty of scheduling these changes for a later time
List 8 items that the expense charges of an insurance company would be expected to cover
COST RAID
Commission
Overheads
Sales / advertising
Terminal, e.g. paying benefits
Renewal administration ,e.g. collecting premiums
Asset management
Initial administration
Design of the contract
Explain the significance of cross-subsidies within a class of business in relation to contract design
3
- Cross-subsidies occur when certain policies contribute more to profit and overheads than other policies.
- Where there are cross subsidies, the mix of business written becomes important!
- If the actual mix is different to the expected mix, then profits may be higher / lower than expected
Give examples of conflicts between contract design factors
- Profitability vs competitiveness
- Avoiding cross-subsidies vs simplicity of administration
- Offering options and guarantees vs minimizing risk
- Offering options and guarantees vs financing requirements
- Offering options and guarantees vs simplicity of administration
- Marketability vs strict terms and conditions
Stakeholders involved in contract design:
- Actuaries
Actuarial will be involved in
- the INITIAL COSTING of the financial structures
- the subsequent determination of the PROVISIONS that will need to be held to meet future liabilities.
- the DESIGN through assessing the impact of both the cost and reserving implications on modifications to the benefit design.
Stakeholders involved in contract design:
- Lawyers
Involved in DRAFTING THE CONTRACTS supporting the financial structures
to ensure that the provider is not exposed to the risk of
…. providing more benefits
…. or entering into greater risks
than intended.
Stakeholders involved in contract design:
- Accountants
involved in ensuring that the provider of the financial structures PROPERLY ACCOUNTS for their income and outgo.
Stakeholders involved in contract design:
- Financial backers
Financial backers will want REGULAR REPORTS demonstrating proper stewardship of the finance provided.
Stakeholders involved in contract design:
- Administrators
Need to ADMINISTER the financial structures.
The more complex the financial structures, the greater the cost of administration will be.
Regulation can affect (5)
- CAPITAL REQUIREMENTS of a contract
- contract DESIGN
- PREMIUM (min or max)
- SALES METHOD used
- level of UNDERWRITING allowed
