CH:24 Pricing and financing strategies

Question 1

What is the difference between the cost and the price of a set of benefits?

Answer 1

The cost of benefits is the amount that should theoretically be charges 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.

Question 2

List other factors to consider when determining the cost of benefits
(excluding the value of expenses to be incurred and contribution to profit)

(9)

Answer 2

• tax
• commission
• the cost of any capital supporting the product
• margins for contingencies
• the cost of any options and guarantees
• the provisioning basis
• experience rating
• investment income
• reinsurance

Question 3

Give 5 reasons why the price charged might differ from the cost for an insurance contract

Answer 3

• 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.
• The provider might have a captive market, such as an affinity group, that is not price sensitive.
• A cheaper price might also be the result of the provider taking a lower or no contribution to expense overheads and profit.
• Loss leader: a cheap product may attract customers to other, more profitable products of the company.
• Underwriting cycle: there may only 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.

Question 4

List 6 ways of financing pension scheme benefits

Answer 4

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
7. All financing strategies are influenced by RISK TOLERANCE and TAX TREATMENT.

Question 5

Give three reasons why the actual contribution rate might differ from the calculated theoretical cost of the future benefits in a pension scheme

Answer 5

• 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 surplus and the contribution rate may be reduced to eliminate the surplus.
• The sponsor may want to alter the pace of funding by paying a higher or lower contribution in any year.
• There might be legislative restrictions (upper and lower) on contributions.

Question 6

4 Examples of distributions systems

Answer 6

• independent intermediaries
• tied agents
• own sales force
• direct marketing