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3. Exam 3 > Chapter 10: Contract Design > Flashcards

Chapter 10: Contract Design Flashcards

1
Q

Contract factors

A 
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.

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2
Q

Who are the parties in contract design?

What are their needs and interests?

A
  • Client
  • Client’s customers
  • Financial backers
  • Actuaries
  • Lawyers
  • Accountants
  • Administrators
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3
Q

Needs of the client

A

Needs are influenced by

  • cost efficiency,
  • the chosen market,
  • the capital available
  • expertise available
  • and its objectives.
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4
Q

Needs of the client’s customers

A

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
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5
Q

Needs of the lawyer

A

Involved in drafting of the contracts

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6
Q

Needs of the accountants

A

Ensure that income and outgo is correctly accounted for.

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7
Q

Needs of the financial backers

A

Require regular reports on the use of their funds

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8
Q

Needs of administrators

A

Want simplicity.

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9
Q

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

A

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

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10
Q

What do the level and form of the benefits depend on

A
  • the risks to be covered
  • the client’s needs
  • the client’s ability to pay
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11
Q

How might you charge for options and guarantees

A
  • as an upfront charge

- as a reduction in benefits when they fall due

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12
Q

2 Main ways of financing benefits

A
  • funding in advance

- pay-as-you-go

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13
Q

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

A 
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)

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14
Q

Initial administration expenses

A

e.g. setting up new client records

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15
Q

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

A

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

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16
Q

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

A

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

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17
Q

How might regulatory requirements influence contract design?

A

Might have a direct impact on:

  • the benefits
  • premiums
  • investments

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

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18
Q

What is the Contract Design Acoronymn?

A

AMPLE DIRECT FACTORS

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19
Q

What are the factors in the first word of the Contract Design acronymn?

A 
AMPLE
Admin systems
Marketability
Profitibility 
Level and form of benefits
Early leaver benefits
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20
Q

What are the factors in the 2nd word of the Contract Design acronymn?

A 
DIRECT
Discretionary benefits
Interests and needs of customers
Risk appetite
Expenses vs charges
Competition
Terms and conditions of contract
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21
Q

What are the factors in the 3rd word of the Contract Design acronymn?

A 
FACTORS
Financing (capital requirements)
Accounting implications
Consistency with other products
Timing of contributions or premiums
Options and guarantees
Regulatory requirements
Subsidies (cross)
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22
Q

What costs do product providers need to think about?

A

RAPID COST

Renewal admin
Asset managements
Profits
Initial admin
Design of contract

Commission
Overheads
Sales/advertising
Terminal e.g. paying benefits

23
Q

What are the characteristics of a well run project?

A

PROJECT CRAMPS

Planning (full)
Risk analysis (thorough)
Objectives (clear and reflect customer needs)
Judge (monitor) development
Excellent intercommunication
Conflict management (leads to development)
Thorough testing at all stages

Critical path analysis
Relationships with external suppliers (challenging and stable)
Appropriate pace, so deadlines reach on time
Milestones review schedule
Performance and quality standards are set and measured
Supportive environment

24
Q

What are the contents of a written strategy document?

A

PROSE

Policies
Roles and responsibilities
Objectives
Schedule
Expected cost
25
Q

What criteria would be used in an initial appraisal?

A

SPURS

Synergies with other projects
Political constraints
Upside potential
Results (financial side)
Scarce resources
26
Q

What tools do you use to identify risks?

A

DR RUB

Desktop analysis
Risk analysis at high level
Risk register/matrix
Upside as well as downside risks identified
Brainstorming
27
Q

What types of risk to the project are there? (identify causes of risk)?

A

PNE FC PB

Political (opposition from 3rd party, sponsors)
Natural (storms/volcanoes)
Economic (interest rate, curr, infln)

Financial (refinancing issues, incorrect cashflow estimates)
Crime (fraud)

Project (poor design, over-budget)
Business (competition, loss of key personnel, safety)

28
Q

What are the fat risk mitigation techniques?

A

FAT SIR

Further research
Avoid
Transfer

Share
Insure
Reduce

29
Q

How do you evaluate risk mitigation options?

A

OFFER

Overall impact on distn of NPV's
Feasibility and cost
Further mitigation required in response to secondary risks
Effect on frequency/severity/correlation
Resulting secondary risks
30
Q

What are the contents of an investment submission? (submission for whether to take on project)

A

FIRM PEN

Financial results (ENPV, distn of NPV’s)
Identifying and analysing key residual risks
Recommendation
Mitigation strategy (best one)

Proposed method of financing it
Effect on investors
Non-Monetary issues, e.g. synergies, political risks

31
Q

What more do you consider beyond the investment submission?

A

LAND HO

Last minute considerations
Allowance for approximations and bias
Nowledge not in possession of those preparing the submission
Doubts over feasibility

Hunch
Overall credibility

32
Q

What are the types of policies considered in the strategy documents

A 
Financial
Legal
IT
Risk management
Tech
Communications
33
Q

What are the 4 things that should DEFINITELY be included in strategy document?

A

AIRS

Aims
Issues necessary for implementing project
Risk areas effecting viability
Strategies for dealing with risk areas

34
Q

What is the definition of a capital project?

A

Initial expenditure, with future income and running costs (not necessarily a physical asset constructed)

35
Q

Explain what WACC is?

A

The cost of raising incremental capital to carry out a project, the rate which a project must earn so shareholder are no better/worse off

36
Q

Explain the formula for WACC

A

The weighted average cost of raising capital, with weights set to the optimal proportions of bonholders (debt) and shareholders (equity)

37
Q

What is the WACC formula?

A

WACC=MVdebt/(MVdebt+MVeq) * debtholder req return + MVeq/obvious * eq holder req return

38
Q

What is the debtholder required return?

A

Real return on IL bonds plus margin for creditworthiness * (1-corp tax)

39
Q

What is the equity holder required return?

A

Real return on IL bonds + eq risk prem

40
Q

The WACC is a real discount rate, what does that mean?

A

It should be applied to cashfolows in todays values

41
Q

What do you do to the WACC if project is higher risk than normal?

A

Increase as higher systemic risk, look at other companies, or take arbitrary increase

42
Q

What testing should you do with WACC

A

Sensitivity on different discount rates

43
Q

Why shouldn’t you have a really high discount rate on WACC

A

Because that would mean lower importance on late cashflows so may accept a risky project (gets risky later on)

44
Q

What are the characteristics of a successful team?

A 
Commited to success of project
Leaders are good
Excellent communicator
Friendly but not afraid of each other
Experience is varied
Deadlines are met
45
Q

What are the characteristics of a successful leader?

A 
Motivates
Organisation of resources is good
Decisive action taker
Establish directions
Strong/experiences to drive team forward
46
Q

What are the NPV advantages?

A

Measure of expected added value
Time value of money allowed for
Riskiness (Disc rate) allowed for

47
Q

What are the IRR advantages?

A

Comparison is possible because single number
Understandable
Comparison of CoC to rate of return possible

48
Q

What are the Payback Period advantages?

A

Simple calculation and communication

Periods that are critical are useful, if cashflows are critical to company

49
Q

What’re the NPV disadvantage?

A

Length of project not taken into account

Timing of profits not taken into account

50
Q

What are the IRR disadvantages?

A

Multiple solutions or none are possible
Size of project not taken into account
Length of time of project not taken into account

51
Q

What are the Payback Period disadvantages?

A

Cashflows after payback period not accounted for

Time value of money not accounted for (DPP)

52
Q

Customer needs

A
  • Consider whether contract meets needs of target market
  • Risk appetite, benefits desired (core/ additional), capacity to pay for insurance
  • Current/ future; logical/emotional
  • Flexibility (benefit and premium, amount and timing)
53
Q

Marketability

A

• Additional benefits and innovative products enhance marketability
• Flexibility = marketability
• Guarantees should enhance marketability
• Guarantee too complex = contract more difficult to understand = less marketable
• Consider whether expected sales volumes will be sufficient for the company to make an adequate contribution to fixed expenses and profits
o Rider benefits as opposed to stand alone contract= greater volume sold (easier to see “optional extra” than completely new product)
• Min/ max prem/cont/benefit = reduced marketability (restrictive for low/high earners)
• Weak discontinuance terms = reduced marketability
• Potential prizes increase marketability but must involve reasonable chance of winning
• Low charges and transparency increase marketability

3. Exam 3 (52 decks)

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