Ch 23: Contract design Flashcards

1
Q

List 18 factors to consider when designing or redesigning a contract

A

AMPLE DIRECT FACTORS

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-)
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2
Q

List the 7 key parties involved in contract design

A

ALPACAS

Actuaries
Lawyers
Providers of benefits
Accountants
Customers
Administrators
Shareholders / financial backers
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3
Q

List the factors influencing the needs of the provider

A
  1. The chosen market
  2. The capital available
  3. The expertise available
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4
Q

List the factors influencing the needs of the customer

A
  1. The capacity to pay
  2. The risks they need to be covered
  3. The benefits that are needed at different times in the future
  4. Attitude to financial risk
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5
Q

Give examples of how a contract can be designed to cater for different risk appetites amongst customers

A
  1. Different investment funds , e.g. low, medium and high risk
  2. Different levels of cover, e.g. comprehensive vs third party
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6
Q

Give examples of how the regulatory environment may influence the design of a product

A

Products must meet legal or regulatory requirements, if any.

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 β€˜cooling-off’ period.

Regulation may require information to be disclosed to potential customers, for example discontinuance terms.

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7
Q

Give examples of contract design features that make a contract more marketable

A
  1. Guarantees, options and choices
  2. A competitive (low) price
  3. Transparency and simple to understand
  4. Features that distinguish it from the competitors
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8
Q

Give examples of options relating to premiums, benefits, the use of proceeds and any other options that might be offered as part of a contract design

A
  1. Premium options:
    - waiver of premium
    - option to increase / decrease premium
    - option to choose / change premium frequency
  2. Benefit options:
    - discontinuance
    - early or late or ill-health retirement
    - spouse’s benefits
    - rider benefits
    - option to protect a no-claims discount
  3. Use of the contract proceeds:
    - choice of annuity provider
    - choice of hospital under health insurance
  4. Other options:
    - option to renew / convert a term assurance without further underwriting
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9
Q

List examples of guarantees that might be offered as part of a contract design

A
  1. Guaranteed benefits
  2. Guaranteed minimum maturity value
  3. Guaranteed minimum growth rate
  4. Guaranteed annuity rates
  5. Guaranteed premiums
  6. Guaranteed charges
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10
Q

What is the underlying principle to consider in setting discontinuance terms for an insurance company or benefit scheme?

A

FAIRNESS between:

  • the policyholder or member who is leaving
  • the remaining policyholders or members
  • the provider of the benefits
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11
Q

Surrender

A

The policy stops, there is no further cover and the policyholder receives a lump sum payment (the surrender value)

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12
Q

Lapse

A

The policy stops, there is no further cover and usually no payment is made to the policyholder by the insurance company

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13
Q

Paid-up

A

The policyholder ceases to pay premiums but the policy continues to offer the policyholder some cover.

In this case the benefit is reduced to reflect that there are no more premiums and is called the paid-up value.

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14
Q

Withdrawal

A

This normally encompasses surrender and lapse, as the policy does not stay in force.

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15
Q

How does an insurance company decide on which contracts to offer discontinuance terms?

A

It will look at:

  • market practice
  • regulatory requirements
  • anti-selection risk
  • the difficulty and cost of assessing and implementing suitable terms

The insurer may also consider past practice.

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16
Q

Factors to consider when determining discontinuance terms

A

Fairness, hence the starting point will be the β€˜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
17
Q

Main factors to consider in determining suitable discontinuance terms for an individual leaving a benefit scheme

A
  1. Fairness between the leaving member and those staying
  2. Whether the member want to stay in the scheme as a deferred member or take a transfer value to another scheme
  3. The scheme’s funding level at the point of discontinuance
  4. Regulation / legislation affecting discontinuance terms
  5. Administration expenses of determining and implementing the terms
  6. Ease of calculation and frequency of change if terms
18
Q

Define β€˜new business strain’

A

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 capital requirement (to finance the shortfall)

19
Q

List ways in which a contract could be designed in order to reduce new business strain

A
  1. Avoid options and guarantees
  2. Match charges with expenses, and keep charges variable.
  3. Low initial expenses / commission
  4. Offer contracts with low statutory provisioning requirements.
  5. Use single premiums rather than regular premiums
20
Q

List four methods of financing benefits

A
  1. Pay as you go
  2. Funding all the benefits in advance
  3. Regular payments building up a fund
  4. Paying an amount when the benefit even happens, for example purchasing an annuity at the point of retirement
21
Q

Outline the main administrative considerations that relate to contract design

A

These include:
1. whether to outsource the administration or perform it in-house

  1. whether existing systems can carry out the functions that have been built into the product design
  2. the need to produce a new or updated product literature
  3. the cost of making systems and admin process changes
  4. 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
22
Q

List 8 items that the expense charges of an insurance company would be expected to cover

A

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

23
Q

Explain the significance of cross-subsidies within a class of business in relation to contract design

A

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

24
Q

Give examples of conflicts between contract design factors

A
  1. Profitability vs competitiveness
  2. Avoiding cross-subsidies vs simplicity of administration
  3. Offering options and guarantees vs minimizing risk
  4. Offering options and guarantees vs financing requirements
  5. Offering options and guarantees vs simplicity of administration
  6. Marketability vs strict terms and conditions
25
Q

Stakeholders involved in contract design:

- Actuaries

A

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.
26
Q

Stakeholders involved in contract design:

- Lawyers

A

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.

27
Q

Stakeholders involved in contract design:

- Accountants

A

involved in ensuring that the provider of the financial structures PROPERLY ACCOUNTS for their income and outgo.

28
Q

Stakeholders involved in contract design:

- Financial backers

A

Financial backers will want REGULAR REPORTS demonstrating proper stewardship of the finance provided.

29
Q

Stakeholders involved in contract design:

- Administrators

A

Need to ADMINISTER the financial structures.

The more complex the financial structures, the greater the cost of administration will be.

30
Q

Regulation can affect (5)

A
  • CAPITAL REQUIREMENTS of a contract
  • contract DESIGN
  • PREMIUM (min or max)
  • SALES METHOD used
  • level of UNDERWRITING allowed