Chapter 1 - Life Insurance Products 1 - Endowment

Question 1

What is the new business strain?

Answer 1

New business strain occurs when the difference between the asset share and the sum of the supervisory reserves and the required solvency capital is negative.

Premium paid at start of contract,
less initial expenses, including commission payments,
isn’t enough to cover the required solvency capital and supervisory reserve that the company needs to set up at that point.

Normally negative in the early years because there is a high level of expenses incurred at the start of the contract.

Question 2

What kind of customer needs might exist for customers at different age groups?

16 - 25 (4,4)

25 - 25 (5,4)

35 - 65 (4,4)

65+ (4,3)

Answer 2

• 16 -25 of age
  likely situation
  higher education/fist job, partner or not, probably no home, probably no dependants
  needs
  Life insurance needs are probably zero, as there are likely to be no dependants. There is possibly
  a need for savings (eg towards house purchase) but this is likely to be too short term and too
  small to be well served by life insurance products.
• 25 - 35 of age
  likely situation
  maybe partners/children, large debts, moderate income, high expenditure, often not much wealth
  needs.
  This is a key period for life insurance protection, because of the high debt, high expenditure and financial dependence of the family on continued employment. A demand for term assurance at this stage. Policy durations should be at least as long as the main expected period of dependency (eg until children become independent). For example, the protection products described above might be taken out on a unit-linked basis, especially as this provides more flexibility to change levels of cover in future as needs change over time.
• 35 - 65 of age
  likely situation
  children become independant, debts reduce, income may increase, redundancy periods may occur
  needs
  This is the biggest period of demand for retirement, wealth transfer and other savings vehicles. In all cases the emphasis will be on the levels of return provided on the investment, so with-profits or unit-linked products would be normal. Whole life assurance would be most useful for accumulating wealth to be transferred on death,
  again on a unit-linked or with-profits basis.
• 65+ of age
  likely situation
  employment into retirement, few debts, much lower income, more accumulated wealth
  needs
  Immediate annuities will be sold to convert assets into income, in order to protect individuals
  from the risks of running out of money into old age.

Question 3

List and discuss 5 factors that influence the capital requirements of a life insurance product

Answer 3

1. Frequency of premium pmts
   more upfront = less capital intensive
   Regular monthly premium (most capital needed).
   Regular annual premium.
   Single premium (least capital needed).
2. Initial expenses
   higher initial expenses increase capital requirement if premium doesn’t increase
3. Solvency capital requirements
   need assets to cover supervisory and required solvency capital
4. Contract design
   whether contract design allows reserves/solvency margin to remain low
   lower initial reseves = lower initial capital requirement
   slower increase in reserves over contract term, faster invested capital is release
5. Reserving basis (level of prudence)
   reserving basis stronger, requires more capital than would be required under pricing basis

Question 4

Describe an endowment contract

Answer 4

1. Pays benefit on survival to known date (savings need)
   retirement lump sum, repay capital on interest only loan
2. May also pay death benefit during term (protection need)
3. Can be used to transfer wealth e.g nominate child beneficiary
4. Normally has surrender value.
   Usually increases over time
   Depends on contract design
   Not necessarily related to sum assured
5. Can have a paid up value too
6. Group version exists
   e.g. by employers as part of remuneration package
   e.g. retirement benefits, or death-in-service benefit

Question 5

Discuss the risks to an insurance company that arise from endowment assurances

Answer 5

1. Investment risk
   depends on contract design/form
   greatest for without-profits contracts, lower for with-profits contracts, lowest for unit-linked contracts
2. Mortality risk
   depends on level/nature of death benefit
   big death benefit: high at start, reduces with duration IF
   return of premiums/fund: low mortality risk, except near start
   no death benefit: more survivors = more benefits paid
3. Withdrawal risk (persistency)
   depending on withdrawal value compared with asset share
4. Expense risk
   Marginal costs (e.g. comm), fixed costs (e.g salaries)
   Risks arise because of
   inflation
   inability of management to control expenses
   lower than expected sales
5. Anti-selection
   policyholder choice to take out contract based on own knowledge of health
6. Concentration of risk
   particularly for group contracts e.g. multiple deaths of people in same residential area due to catastrophe

Question 6

Risks under group contracts

Answer 6

Pro:
The group version of the contract adds no additional risks and any anti-selection risk is likely to be much reduced, particularly if it is compulsory for all eligible members to join the group contract.
Cons:
grouped nature of the contract does mean that a concentration of risk may arise.
For example, the contract might cover employees in the same workplace, where an industrial accident could result in a number of claims.

Question 7

Persistency risk vs Mortality risk

Answer 7

When we were talking about mortality risk, we looked at the death strain – the difference between the death benefit and the reserve of the policy at the time of death. But when we talk about withdrawal risk, we are looking at the difference between the withdrawal benefit and the asset share at the time of claim.

Question 8

Reserve vs Asset Share

Answer 8

The reserve (by which we mean the supervisory reserve) is how much physical money the company is actually holding towards the liability under the policy. The asset share represents how much money the company has accumulated to date from the historical cashflows from the policy.

 [claim cost] – [reserve] is the capital loss incurred by the policy at the time of claim
 [claim cost] – [asset share] is the overall accumulated loss from the policy at the point immediately after the claim has been paid.

Question 9

pricing and supervisory reserving bases

Question 10

Define anti-selection

Answer 10

People being more likely to purchase insurance when they beleive their risk is higher than insurer has allowed for in premiums/pricing.