Ch 24: Pricing and financing Flashcards
What is the difference between the costs and the price of a set of benefits?
The cost of benefits is the amount that should theoretically be charged for them.
The price of benefits is the amount that can actually be charged under a particular set of market conditions. It may be more or less than the cost.
Formula for the value of premiums to charge
Value of premiums = value of benefits + value of expenses + contribution to profit
List other factors to consider when determining the cost of benefits
1) Tax
2) Commission
3) The cost of any capital supporting the product
4) Margins for contingencies
5) The cost of any options and guarantees.
6) The provisioning basis
7) Experience rating
8) Investment income
9) Reinsurance
Give 5 reasons why the price charged might differ from the cost for an insurance contract
1) The provider’s distribution system for the product enable it to sell above the market price, or to take advantage of economies of scale and reduce the premiums charged.
2) The provider might have a captive market, such as an affinity group, that is not price sensitive.
3) A cheaper price might also be the result of the provider taking a lower or no contribution to expense overheads and profit.
4) Loss leader: A cheap product may attract customers to other, more profitable products of the company.
5) Underwriting cycle: There may be a limited number of providers in the market and so higher premiums can be charged. Alternatively, if there are lots of providers in the market, premiums will fall.
List 6 ways of financing pension scheme benefits
1) Pay-as-you-go
2) Smoothed pay-as-you-go
3) Terminal funding
4) Just-in-time funding
5) Regular contributions
6) Lump sum in advance
All financing strategies are influenced by RISK TOLERANCE and TAX TREATMENT
Pay-as-you-go
Benefits are met out of current revenue and there is no funding
Smoothed pay-as-you-go
The same as pay-as-you-go but with a small fund to smooth the effects of timing differences between contributions and benefits, short-term business cycles and long term population change.
Terminal funding
A lump sum is set aside to cover all the expected benefit costs when the first tranche of business becomes payable.
Just-in-time funding
Funds are set aside only in response to an external event such as the sale of an employer.
Regular contributions
Funds are gradually built up between promise and first benefit payment.
Lump sum in advance
A lump sum is set aside to cover the expected benefit cost when the benefit is promised.
Give 3 reasons why the actual contribution rate might differ from the calculated theoretical cost of the future benefits in a pension scheme (3)
1) The scheme may be in a deficit and the contribution rate may have to be increased to eliminate the deficit. Alternatively, the scheme may be in a surplus and the contribution rate may be reduced to eliminate the surplus.
2) The sponsor may want to alter the pace of funding by paying a higher or lower contribution in any year.
3) There might be legislative restrictions (upper and lower) on contributions.
3 Factors influencing the price
- Distribution channels implied
- Level of competition in the market
- Premium frequency
Think about the things to consider when a model spits out a premium:
- Distribution channel
- Product design
- Size of market (competition)
- Profit requirement
2 Ways of viewing a product price
- Factor a profit criterion into the pricing process, and thus calculate the resultant premium. Test whether the premium is acceptable in the market.
- Input the desired premium into the pricing model and calculate the resultant profit. Test whether this is acceptable to the company.
4 Examples of distribution systems
- Independent intermediaries
- Tied agents
- Own sales force
- Direct marketing
