Chapter 10: Contract Design

Question 1

Contract factors

Answer 1

A - Administration systems
M - Marketability
P - Profitability
L - Level and form of benefits
E - Early leaver benefits

D - Discretionary benefits
I - Interests and needs of customers and other stakeholders
R - Risk appetite
E - Expenses vs charges
C - Competition
T - Terms and Conditions of contract

F - Financing requirements
A - Accounting implications
C - Consistency with other products
T - Timing of contributions
O - Options and guarantees
R - Regulatory and Statutory requirements
S - Cross-SUBSIDIES

Consider potential conflicts between these factors.

Question 2

Who are the parties in contract design?

What are their needs and interests?

Answer 2

• Client
• Client’s customers
• Financial backers
• Actuaries
• Lawyers
• Accountants
• Administrators

Question 3

Needs of the client

Answer 3

Needs are influenced by

• cost efficiency,
• the chosen market,
• the capital available
• expertise available
• and its objectives.

Question 4

Needs of the client’s customers

Answer 4

Needs are influenced by

• their capacity to pay,
• risks to be covered,
• benefits needed at different points in the future, their -
• attitude to risk
• financial sophistication

Question 5

Needs of the actuary

Answer 5

Involved in pricing and provisioning

Question 6

Needs of the lawyer

Answer 6

Involved in drafting of the contracts

Question 7

Needs of the accountants

Answer 7

Ensure that income and outgo is correctly accounted for.

Question 8

Needs of the financial backers

Answer 8

Require regular reports on the use of their funds

Question 9

Needs of administrators

Answer 9

Want simplicity.

Question 10

How would a savings product meet a wide range of risk appetites?

Answer 10

By offering a WIDE RANGE OF FUNDS and therefore meeting customers’ different and changing needs over the policy term

Question 11

What do the level and form of the benefits depend on

Answer 11

• the risks to be covered
• the client’s needs
• the client’s ability to pay

Question 12

How might you charge for options and guarantees

Answer 12

• as an upfront charge

- as a reduction in benefits when they fall due

Question 13

2 Main ways of financing benefits

Answer 13

• funding in advance

- pay-as-you-go

Question 14

9 Examples of expenses and other factors that should be covered by loadings on the premium

Answer 14

R - Renewal administration expenses
A - Asset management expenses
P - Profit loading
I - Initial administration expenses
D - Design expenses

C - Commission
O - Overheads
S - Sales and Advertising expenses
T - Terminal expenses (eg paying benefits)

Question 15

Initial administration expenses

Answer 15

e.g. setting up new client records

Question 16

What does it mean for a product to be “profitable”

Answer 16

the premiums charged should cover the benefits and expenses in most foreseeable circumstances.

Question 17

What should a provider consider in relation to the riskiness of the contract?

Answer 17

How much risk it is willing to absorb internally or to reinsure.

Question 18

How might regulatory requirements influence contract design?

Answer 18

Might have a direct impact on:

• the benefits
• premiums
• investments

Might have an indirect impact on:
- the level of provisions required.