Ch 4: Life ins prods - Bases, unit linked

Question 1

Describe 4 bases on which life insurance products can be written

Answer 1

• Conventional without profits
  
  • guaranteed benefits, usually level regular premiums
• With-profits
  
  • conventional/accumulating
  • 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/economic index

Question 2

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

Answer 2

1. Policyholders’s premiums paid into investment fund, buys units
2. Value of unit fund depends on value of assets underlying investment fund, equal to units x UP
3. Used for savings and protection
4. Initial expenses
   
   • can be catered for by low allocation rate at start
   • moderately reduced allocation rate
   • capital units (attract higher charge) vs accumulation units
5. Insurer deducts charges from policyholder’s unit fund
   
   • from premium before invested
     
     • allocation rate, bid-offer spread, fixed amt per premium
   • from unit funds
     
     • fund management charge, fixed regular fund charge, regular charges taken to cover death benefits excess of fund value
6. Maturity value usually equal value of units
7. Death benefit may exceed FV of unit fund.
8. Surrender value is FV of unit fund, possibly with surrender penalty.

Question 3

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

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

Answer 3

• 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

Question 4

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

Answer 4

• Conventional without-profits
  
  • high guarantees imply higher cost
  • usually least flexible (to alter premiums/benefits)
• With-profits
  
  • typically lies somewhere between other two in terms of cost, guarantees and flexibility
• 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 5

State 3 main charging structures used to meet initial expenses for unit-linked policies

Answer 5

1. Very low, or zero, initial allocation rate
2. Reduced allocation rate for significant part of term policy
3. Higher regular fund management charge

Question 6

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

Answer 6

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 constraints on charges
3. Anti-selection risk as for comparable non-linked products
4. Selective withdrawal risk may be higher due to transparency of fees
5. Withdrawal/persistency risk depends on
   
   • asset share compared to withdrawal benefit
   • which may not be guaranteed in amount, but its method of calculation
6. Investment risk influence by non-unit related guarantees
   
   • fund management charges based on the fund value
7. Expense risk
   
   • less if charges are reviewable, legislative restrictions on this
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 7

Describe index linked contracts (4)

Answer 7

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. Main risk to insurer, peculiar to these contracts, relates to investment, i.e.
   
   • being unable to invest in a way to precisely match the benefit guarantee (i.e. assets held don’t move in line with economic/investment index)

Question 8

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

Answer 8

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

Question 9

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

Answer 9

1. Insufficient cover
   
   • policyholder reduces guaranteed cover, expecting future bonuses
   • investment peformance worse than expected=> lower bonuses
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 10

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

Answer 10

1. Investment risk
   
   • Long term poor performance (in terms of the average annual return over time)
   • Value low on benefit payment (short term volatility)
2. Insufficient cover
   
   • Guaranteed death benefit likely to be in monetary terms
     
     • Influenced by inflation
3. Insurer insolvency
4. Additional underwriting to increase guarantee

Question 11

Describe risks of index-linked contracts from the policyholders’ point of view (3)

Answer 11

1. 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
   
   • premiums not keeping up with changes in disposable income
   • benefits not keeping up with changes in life cycle

Question 12

Define unit fund

Answer 12

Unit fund defines the policyholder’s (basic) benefit, and the company has a liability to pay this amount at the time of claim

Question 13

Define non-unit fund

Answer 13

The accumulated value of all the charges the company has taken out of its unit-linked policies, less all the actual costs it has incurred on behalf of those contracts, less any distribution of profit it has made to its providers of capital, plus any capital injections paid in

Question 14

Types of charge

Answer 14

• Reduced allocation rate.
• Bid-offer spread.
• Administration fee. (Could be fixed or could escalate each year. Could be taken from the premium or from the unit fund.)
• This might also be called a policy charge or policy fee.
• Fund management charge.
• Switch charge.
• Mortality charge.
• Charges for other benefits.