Ch 4: Life ins prods - Bases, unit linked

Question 1

Describe 4 bases on which life insurance products can be written

4, 1,2,3,1

Answer 1

• Conventional without profits
  
  • guaranteed benefits, usually level regular premiums
• With-profits
  
  • conventional/accumulating : dep on how bonuses are allocated.
  • policyholder shares in part/all of future surplus (from within contracts, or other contracts)
• Unit-linked
  
  • benefits linked directly to performance of specified fund, characterised by fewer guarantees on benefits/premiums
  • greater flexibility
  • can be used for savings and protection
• Index-linked
  
  • benefits guaranteed to move in line with performance of specified investment index/econimic index

Conventional: benefits expressed in terms of claim date and not current. eg Death ben and Mat val
Accumulating: have their benefits defined as some accumulated value of premiums paid to date of claim, and so are not known in advance.

Question 2

For each of the following products, suggest most likely product basis:

• term assurance
• whole life assurance
• endowment assurance
• immediate annuity

Explain factors that product structure depends on 3

Answer 2

• Term assurance
  
  • conventional without profits
• Whole life assurance
  
  • unit-linked, or with-profits
  • new conventional without-profits is rare
• Endowment assurance
  
  • unit-linked or with-profits
  • new conventional without-profits is rare
• Immediate annuity
  
  • conventional without-profits or index-linked
• Structure depends on:
  
  • Costs and risks to PH
  • Flexibility of design
  • RIsks, Cap req, Profits to insurer

Question 3

Compare conventional without-profits, with-profits and unit-linked products from the consumer’s point of view in terms of cost, flexibility and guarantees

3 ,2,2,2

Answer 3

• Conventional without-profits
  
  • high guarantees imply higher cost for PH
  • usually least flexible (to alter premiums/benefits)
• With-profits
  
  • typically lies somewhere between other two in terms of cost,
  • guarantees and flexibility increase this cost
• Unit-linked
  
  • higher/lower expected benefit/premium for given premium/benefit
  • flexibility in types of levels of cover included, ability to vary premiums according to need

Question 4

Explain why UL policies have lower premiums for the same level of benefit

4

Answer 4

• Lower guarantees, investment risk passed to PH
• Reviewable charges:
  
  • increase if poor experience ==> pass to PH
• Lower risk ==> smaller margins==> lower charges for level of profit==> lower premiums

do eg 4.6 4.7

Question 5

Outline the key features of unit-linked contracts (8)

1,1,(2,3),1,4,1,1,1

Answer 5

1. Policyholders’s premiums paid into investment fund, buys units
2. Value of unit fund = bid value of assets underlying investment fund, equal to UxP
3. Insurer deducts charges from policyholder’s unit fund
   
   • from premium before invested
     
     • goes to non-unit fund
     • fixed amt/% per premium,bid-offer spread,
   • from unit funds
     
     • fund management charge, fixed regular fund charge, regular charges
     • taken to cover death benefts excess of FV,expenses
     • Cancel UxP = to charge amount.
4. Used for savings and protection
   
   • Protection: min guar death ben, profit and margins in risk charges
5. Initial expenses
   
   • can be allowed for by low allocation rate at start
   • moderately reduced allocation rate till the medium term
   • Higher fund charge for term
   • issue capital units (attract higher charge) vs accumulation units
6. Maturity value= bid value of units
7. Death benefit may exceed FV of unit fund.==> risk charge for guar
8. Surrender value is FV of unit fund, possibly with surrender penalty.

Question 6

Describe the Non-Unit fund

4 3,1,1,1

Answer 6

• Accum value of charges less
  
  • actual costs incurred
  • profit distributions
  • plus capital injections
• Non allocated premiums fund the non-unit fund. Charges are expensed here.
• A policies contribution to the non-unit fund = AS- UxP
• Profit=(charges-act costs) + (risk charge - Cost guar ben>UxP)

Question 7

Describe risks faced by an insurer which sells unit-linked contracts (9)

1,2,1,1,3,3,2,2,1,

Answer 7

1. Less guarantees => likely lower risk than non-linked contracts
2. Nature/extent of risks influenced by
   
   • nature/level of any guarantees,
   • any marketing/legislative contraints on charges
3. Anti-selection risk
   
   • similar to non-linked products
4. Selective withdrawal risk may be higher due to transparency of fees
   
   • poor experience, inc charges vs competitors, lapse good risks
5. Withdrawal/persistency risk depends on
   
   • asset share compared to withdrawal benefit
   • which may not be guaranteed in amount, but its method of calculation
   • surr penalty reduces this risk
6. Investment risk
   
   • Influenced by non-unit guarantees offerred
   • Passed to PH
   • Exposure if charges are based on fund value
7. Expense risk
   
   • less if charges are reviewable,
   • legislative restrictions on charges increase risk
8. Mortality risk depends on
   
   1. guarantees given,
   2. competition: selective withdrawals leaving worse lives
9. Significant marketing risk (due to low level of guarantees)

Question 8

Explain the difference between Asset share and Unit fund value

2

Answer 8

• Asset share = Accum val premiums - Actual costs
• Unit fund = Accum val of allocated premiums - benefits

eg on pg 15

Question 9

Describe the capital requirements for UL policies

1,2,2

Answer 9

• Depend on the design on the contract vs 5 factors
• eg Reg prem w/low alloc rate @ start
  
  • +CF’s==>repay cap strain==>reduce amount of capital held
  • Reg Prem => recoup initial expenses and generate profit slowly via charges
• Take credit for future charges in adv
  
  • EPV of fut charges used to offset initial expenses
  • Adj Reserve= Reserve - EPV expense charges

Question 10

Describe index linked contracts (5)

1,1,1,5,1

Answer 10

1. Benefits are guaranteed to move in line with economic performance of investment/economic index in specified contract
2. Single or regular premiums
3. Surrender value, if applicable, would normally be value of benefits calculated according to index value at time of surrender
4. investment risk:
   
   • being unable to precisely match the benefit guarantee
   • i.e. assets held don’t move in line with economic/investment index
   • Non traded assets, high expenses, reg restricts investments etc
   • Aim to match broad movements to reduce trading expenses
   • Insurer bear risk
5. PH bears risk of adverse movements in the index.

Question 11

Describe risks of conventional without-profits contrats from the policyholders’ point of view (5)

Answer 11

1. Insufficient benefit…
2. ..made worse by inflation over time
3. Insurer insolvency, unable to fully meet guaranteed benefits.
4. Inflexibility of product to keep pace with
   
   • changing disposable income of policyholder
   • changing amounts of benefit needed throughout financial life
5. Unaffordability of premiums
   
   • accident
   • sickness
   • redundancy
   • other loss of income
   • mitigate with other insurance

Question 12

Describe risks of with-profits contracts from the policyholders’ point of view (4)

Answer 12

1. Insufficient benefits
   
   • policyholder reduces guaranteed cover, expecting future bonuses to + ben level
   • investment peformance worse than expected=> lower bonuses
   • or bonuses distributed via - prem / cash payout
2. Insurer insolvency
   
   • less than under conventional business <= future surpluses can be used to maintain solvency before being distributed
3. Inflexibility
   
   • changing disposable income of policyholder
   • changing amounts of benefit needed throughout financial life
4. Unaffordability
   
   • accident
   • sickness
   • redundancy
   • other loss of income

Question 13

Describe risks of unit-linked contracts from the policyholders’ point of view (5)

Answer 13

1. Insufficient benefits
   
   • Guaranteed death benefit likely to be in monetary terms
     
     • Eroded by inflation
   • Investment risk
     
     • Long term poor performance
     • Maturity on a bad day: ST Vol in UxP
2. Insurer insolvency
3. Additional underwriting to increase guarantee
4. Unaffordability

Question 14

Describe risks of index-linked contracts from the policyholders’ point of view (4)

Answer 14

1. Insufficiient benefits == Investment risk
   
   • similar to unit linked (long term poor returns; short term volatility)
   • except that they depend on performance of index rather than that of a specifically designated asset
2. Insurer insolvency
   
   • greater risk as insurer takes on investment risk (not policyholder)
   • less scope for reviewing charges for existing index-linked products, potentially increases insolvency risk
3. Inflexible
   
   • prems not keeping up with changes in disposable income
   • benefits not keeping up with changes in life cycle
4. Unaffordability

Question 15

Describe briefly a range of products that the insurer should sell

4

Answer 15

• Attractive range of products that maximises profits
• In the long-run profits would be maximised when utility to customers are maximised
• the Insurer should control and diversify their risk through their business volumes and business mix.
• Take further profitable risks to max economies of scale

Question 16

Provide 8 factors that affect profitability and risk profile of insurers

Answer 16

• Investment policy
• Underwriting
• Reinsurance
• Approach to reserving and profit distribution
• Discontinuance terms
• Monitorinand feedback
• HR and Remun
• Admin, data handling
• Capital management
• Pricing