Chapter 1 Flashcards
What makes pricing insurance products different than most products?
The fact that the cost of the raw materials is not known at the time of determining the life insurance price.
When is the actual profitability of a life insurance product determined?
cannot be determined until policy lapse or when the last policy holder(s) has died
Who determines the setting of the mortality expectations, expenses, interest rates etc?
the product development actuary
What are the two key items an organization needs to consider when determining the cost of the product?
- Have the skill set to appropriately analyze the risk being considered
- Must be Realistic about underlying cost of different offerings
The consumption of life insurance products tends to be driven by what pull?
- The price in the marketplace
- The competition pressure is driven by the accepted belief insurance products are bought as a commodity
Define surplus
The capital that is held above the expected needs of the product to ensure that all policyholder claims are met. Surplus can be assigned based on a products design.
T/F. On a theoretical level, with all ventures, expected returns should correlate directly with the amount of underlying risk present?
True
T/F. The greater the risk, the expected return should be higher in regards to a life insurance product.
True
3 types of risk established by the NAIC through the RBC (risk based capital) formula.
- Asset Risk
- Underwriting/Insurance risk
- Other risk
Define Asset Risk
risk that the assets supporting the product line lose some or all of their value
Define Underwriting/Insurance Risk
risk that the price for the insurance product is inadequate or underwriting standards were not maintained.
Define Other Risk
All other risks (business, interest rate, political risk).
What do you call the management of Interest Rate risk? Define it
This risk management process is known as asset liability management of ALM. the management of this risk has precipitated sig amount of industry work aimed at matching the liability cash flow of a product with the cash flow of the invested assets.
What is the key risk for a Term Product?
Underwriting risk which would be mortality risk.
What is the biggest cost in a life insurance product?
Mortality.
Define the difficulties of preferred risk class product pricicng.
When there is more stringent underwriting, The expected mortality decreases on the block of policies that qualify at this tighter level criteria = more competitive prices. However fewer individuals will qualify under the more stringent underwriting requirements.
Criteria far more stringent than historically defined standards were introduced for preferred classes. What were they?
Focused primarily on cardiovascular risks, requiring better blood pressure, cholesterol, chol/hdl ratios, fhx, other factors
Proposed insureds that just miss qualifying for a company’s preferred rates will likely do 1 of 3 things. Name them.
- Find a company with a slightly less restrictive preferred criteria and obtain an preferred classification from that company.
- They will be unhappy that they did not qualify as preferred and drop out of the buying pool altogether
- They will purchase the residual standard policy from your company
Actuaries are trained to do what?
To think of the dynamics of large groups assuming homogenous risks.
Underwriters are trained to do what?
To think about the absolute risk of the individual in question.
What is the largest decrement affecting the number of policies in force?
The lapses that occur in a product.
When will a lapse hurt profitability?
If a lapse occurs when the premium collected is greater than the mortality cost for the duration.
When will a lapse profitability improve?
If a lapse occurs when the premium collected is less than the mortality cost
T/F. Early duration lapses improve profitability while later duration lapses hurt profitability.
False. Early duration lapses hurt profitability while later duration lapses improve.
Generally, how long does a policy needs to be in place in order to recover the expenses that incurred upon issue?
5 years.
Name some factors in included in the expense levels built into the product.
- Agents compensation
- Corporate overhead
- Support of an agency system
- Advertising
- Underwriting expenses
When ordering additional requirements in order to assess a risk, there is a balancing act to consider in view of the expenses levels and profitability.
What are the 4 factors considered?
- The cost of a requirement
- The corresponding mortality savings (i.e. protective value) that occurs due to obtaining the requirement
- The proposed insureds adverse reaction to being subjected to a battery of requirements for the desired level of coverage
- the time taken to issue a policy
What products have a significant asset accumulation component?
Whole Life, Universal Life
In addition to basic pricing components of a product there are other components established by regulation.
What are these items?
- reserve bias
- non-forfeiture laws
- surplus needs
- tax laws
Define reserve bias
The purpose is to make sure enough of the premium earned in the early duration of a contract is held until the time when the group of policyholder ages and the probability of death is greater than the premium received.
In regards to reserve bias …
In the US, statutory reserve standards are established by state regulation. In Canada, statutory reserves are established by federal regulation.
Define non-forfeiture laws
Allows for the return of excess premiums in the form of a cash value (net of allowing the company to recover its expenses) if the policy holder chooses to lapse the policy.
This can happen if the policyholder pays too much for coverage in the early duration of the contract and not enough in later years.
Define surplus needs
A safety net needs to be provided, beyond the level of reserves being held, in case experience turns out to be much worse than expected.
Federal taxes paid by an insurance company are **income based **and are affected by what 3 main components?
- corporate tax rate
- tax reserves
- DAC (deferred acquisition cost) tax
What is the purpose of DAC tax?
a way to disallow full deductibility of acquisition expenses in the year they were incurred, but rather to force them to be recognized over a 10-year period.
Define tax laws for insurance companies in Canada.
Insurance companies are subject to corporate taxes at a federal and provincial level in much the same way that US companies are. At the federal level, taxes related to the company’s income (federal income tax) and the provincial level they relate to premiums (provincial premium tax).
In simple terms how do you price a product?
Schedule out a series of expected expenses and couple that with a stream of premium payments to produce a profit that meets the corporate requirements for the product. It must also be filed and approved with each state before it is made available for sale in that state.
The interaction between the actuary and the underwriter in product development takes form through two main decision processes.
What are they?
- The setting of the underwriting requirements
- The reasonableness of the pricing expectations
What are the two components in the underwriting requirement process?
- Verifying information obtained from the proposed insured
- Discovering information that is either new to or is being concealed by the proposed insured
what is “protective value” in relation to pricing?
Refers to the relationship of mortality savings from a requirement to the cost of administering the particular requirement.
T/F. To the extent that greater mortality cost is saved than the cost of the requirement, the requirement should be ordered.
True.
Establishing a valid protective value study requires evaluation of what issues?
First, which requirement identified the underlying impairment. Second, the proposed insured’s behavior.
T/F. The purpose of a protective value study should be examined in the context of the underwriting process.
True.
T/F. Many companies look at their competitors when establishing underwriting requirement grids.
True.
T/F. History has proven that if a company establishes underwriting requirements that are “ahead of the market”, then a proposed insured’s behavior will be modified and additional risks will be attracted.
True.
What are the two most important functional areas of an insurance company?
The pricing actuary and underwriter
T/F. One should establish the underwriting grid simply by looking at the competitors.
False. One should not establish the underwriting grid simply by look at the competitors.
T/F. One should never establish the underwriting process without being cognizant of what is common practice in the marketplace.
True.
T/F. It is unusal for the underwriting requirement grid or underwriting processes to change over time.
False. It is not unusual.
What two pieces of information are important for the product development actuary?
Historical behavior of the UW department is already reflected in the underlying underwriting cost structure as well as mortality studies
What is a controversial topic in the underwriting community?
Exceptions
For the best underwriting class, what percentage of people can qualify?
As few as 10-20% can qualify.
In regards to exceptions, an organization should fully document all exceptions that are granted and analyze the type and frequency of exceptions. This information should also be shared with who? To determine what?
Should be shared w/the product actuary to determine the impact on the expected mortality and what adjustments are necessary.
T/F. An early duration claim defines a poor risk or poor decision.
False. An early duration does not define a poor risk or poor decision any more than one that lives defines a good risk.
Feedback mechanism needs to consider what?
Risks that died and risks that lived.
A claim beyond the contestable period can not be contested unless…
except for fraud
What is the key to ensuring ongoing profitability?
make product decisions based on realistic assumptions and then reguarly measure the experience against the assumptions.
Underwriting criteria generally used in the pricing of preferred policies
blood pressure
chol/HDL ratios
family history
What three functions should always have a healthy respect for eachother for success of the product?
The underwriting, actuarial, and marketing functions.
What are life insurance pricing components that are established by regulation?
reserve basis
tax law
non-forfeiture laws
What is the relationship of mortality savings from a requirement to the cost of administering the requirement?
Protective value
Protective value study should..
- evaluate which requirement identified the underlying impairment
- consider the PIs behavior in accepting or rejecting the offered policy
- ensure that the offered product is “at the market”
A safety net that needs to be provided beyond the level of reserves being held in case a company’s mortality experience turns out to be much worse than expected is referred to as:
Risk based capital
