CH:23 Contract design

Question 1

What are the main factors to consider when designing a contract?

Answer 1

A - Administration system
M - Marketability
P - Profitability
L - Level and form of benefits
E - Early leaver benefits

D - Discretionary benefits
I - Interest/need of the customer
R - Risk appetite
E - Expenses vs charges
C - Competition
T - Terms and conditions

F - Financing (capital requirements)
A - Accounting implications
C - Consistency with other products
T - Timing of contributions or premiums
O - Options and guarantees
R - Regulatory requirements
S - Subsidies (cross)

Question 2

What influences the needs of a provider and their customers??

Answer 2

Providers:

• Chosen market
• Capital available
• Expertise available
• Liquidity
• Risk appetite

Customers:

• Capacity to pay
• Risks to be covered
• Attitude to risk
• Benefits needed through time

Question 3

What is the difference between surrender, lapse and a paid-up state

Answer 3

Surrender: The policy stops, there is no further cover, no further premiums are paid and the policyholder receives a lump sum payment

Lapse: The policy stops, there is no further cover, no further premiums are paid and no payment is made to the policyholder by the insurer

Paid-up: The policyholder ceases to pay premiums but the policy continues to offer the policyholder some cover. The cover is reduced to reflect that there are no more premiums

Question 4

What to consider under financing when designing a contract

Life insurance

Benefit schemes

Answer 4

Financing has to do with the timing as to when money is set aside to pay for the benefits:

Benefit schemes
* PAYG (unfunded: monies only set aside when benefits fall due)
* Lump sum in advance (funded, funds are set aside when the benefit is promised)
* Regular payments (funding, building up a fund)
* Terminal funding (funded, funds set aside when benefit event happens, buying an annuity at retirement)

Life insurance contracts
* When insurance contracts are written the providers are required to set aside an amount of capital: regulatory capital.
* The capital requirement increase based on the riskiness of the contract, any options or guarantees and the complexity of the contract
* Without profit tends to be more capital intensive than with profit or unit-linked
* Insurers should also consider any new business strain: loss in the first few years