Chapter 12

Question 1

What are the main costs for a LIC in running business?

Answer 1

• Commission to salespeople - can be initial or renewable
• Management expenses

Question 2

When is initial and renewal commission payable?

Answer 2

• Initial - on acquisition of new policy
• Renewal - payable each time renewal premium is paid

Question 3

What can happen in terms of commission if a policy lapses?

Answer 3

Part of the initial commission may be recoverable and there will be a risk of non-recovery.

Question 4

What do management expenses consist of?

Answer 4

Expenses that are incurred directly when:
* Policies are written (initial)
* Policies are maintained (IF)
* Policies are terminated (claims)
Overheads - fixed expenses; do not vary with volume of business. E.g. general management, service departments (IT and HR) and costs of accommodation.

Question 5

Which expense categories are the largest?

Answer 5

Initial and commission.

Question 6

What should be done to expenses to determine the expense loadings built into premiums?

Answer 6

Expenses should be split into various ways to determine the expenses loadings built into premiums.

Question 7

What risks occur wrt expense loadings?

Answer 7

• Profitability risk - risk that loadings will be insufficient to meet actual expenses
• Inflation is a key element of uncertainty and risk associated with future expenses

Question 8

Many underlying costs are …

Answer 8

directly linked to wages/salaries. Others are influenced by general level of prices or by prices of commodities.

Question 9

_______ used to decide on assumptions, e.g. ________

Answer 9

Data
retail price index, national average earnings index and similar internal data to LIC.

Question 10

Describe the volatility of NB, IF and claims volumes.

Answer 10

NB more volatile than IF and claims
IF less volatile than claims

Question 11

How will NB volumes fluctuate?

Answer 11

In line with economic cycles.

Question 12

Renewal and IF business are more …

Answer 12

predictable than NB volumes.

Question 13

Describe the volatility of expenses between NB, renewals and claims.

Answer 13

Renewal expenses much less volatile than NB expenses.
Claim expenses more volatile than renewal expenses but less volatile than NB expenses.

Question 14

The business environment consists of:

Answer 14

• The economic environment
• The legal environment
• The regulatory regime
• The fiscal regime

Question 15

What risk is there for the insurer wrt the economic environment?

Answer 15

• State of the economy will carry risks for insurer.

Question 16

Availability of asset types and ST and LT expected yields will determine:

Answer 16

• Investment policy - how well insurer can choose investments
• Interest rate assumptions - probability of return assumed when setting premium rates

Question 17

What will form the best estimate of future investment return?

Answer 17

Expected yields on assets that the company intends to invest in. This is a key factor in setting the interest rate assumption.

Question 18

What is the solution to uncertainty in future returns?

Answer 18

The IC needs to allow some margins in the basis to cover the event that yields turn out lower than best estimate.

Question 19

Volatility of investment markets will:

Answer 19

• Increase cost of capital for insurers, hence increasing policy prices (due to need for greater reserves)
• Affect the demand for insurance products - clients may view insurance as a more/less attractive investment than other alternatives in the market

Question 20

How should legal risk between the PH and IC be avoided?

Answer 20

Assuming a politically stable operating environment, the written contract between the IC and PH should normally avoid any significant legal risk.

Question 21

Care should be applied to areas of the contract where the insurer has discretion …

Answer 21

• Operations will be influenced by PRE - PRE can have legal force through court rulings, so it can place considerable restrictions on companies.
• Unfair contract terms invalidating clauses of contract needs to be avoided - risk that contract terms removed completely, rather than being amended to fair terms.
• These issues should be sorted out during the development of any product.

Question 22

What is the problem of insurance contracts spanning over many years?

Answer 22

Open to developing legal cultures, interpretations + court judgements.
Biggest risk - new legislation that could change legal contract between IC and PH.

Question 23

General contract legislation may …

Answer 23

outlaw certain policy conditions - restricting company’s ability to manage risk +/ issue certain product designs.

Question 24

Legal risks may arise from …

Answer 24

inconsistencies between policy document + any other relevant representations made by company agents, e.g. inaccuracies in information given to PH regarding contractual terms by broker.

Question 25

What is the aim of the government imposing restrictions on LICs?

Answer 25

* To protect PHs - regulate insurance industry to ensure security of PHs interests. * Generate/maintain confidence - without confidence people will be reluctant to buy insurance. * Reduce financial crime

Question 26

What is the downside of the restrictions imposed by the government on LICs?

Answer 26

It may restrict innovation or reduce benefits that could otherwise be given to PHs.

Question 27

What are the more common regulatory restrictions?

Answer 27

Restrictions on: * Types of contracts that LIC can offer * Premium rates and charges * Rating factors used to calculate premiums * T's & C's relating to the contracts (e.g. how paid-up policies and SVs are calculated) * Channels through which LI sold, sales procedures or on information given at point of sale, e.g. - Min training requirements for salespeople - Cooling off periods - Illustration of possible maturity values or SVs, perhaps on specified/restricted bases * The ability to underwrite * Amount of business that may be written, via min reserving or SCRs - limit the capital available to write NB + place a min requirement on finance to write a contract * Investment

Question 28

LICs are likely to have a monopoly of providing pure protection benefits, ...

Answer 28

but not providing savings benefits.

Question 29

True or False? Other institutions offering savings benefits will usually be subject to different regulatory controls.

Answer 29

True. This leads to non-level playing field with regards to contract terms that can be offered.

Question 30

What are some examples of a sloping playing field between LICs and other institutions offering savings products?

Answer 30

* Different rules for demonstrating capital adequacy * Different rules on advertising products * Different rules on benefit illustrations

Question 31

Why does the regulatory environment have a significant effect on contract design?

Answer 31

Because companies want to make the best use of any regulatory requirements. Contract design will take into account any constraints imposed.

Question 32

What are the aims of climate change related regulations?

Answer 32

* Consider climate risks in: - EB planning - Investment management - Risk management * Disclose and report on climate related risks and opportunities * Incorporate ESG factors into investment management decisions * Use scenario analysis to estimate the impact of financial risks arising from climate change * Consider impact of climate risks on ability to meet PH and other stakeholder obligations * Adopt a consistent means of pricing and managing climate related risks

Question 33

What are the most common approaches to LIC taxation?

Answer 33

* The profits approach * The investment income approach

Question 34

Describe the profits approach to taxation of a LIC.

Answer 34

* Taxes company as if its sole reason for existence is making profit * Tax on the annual profits of the business, measured by change in free assets of the company over the year * Uses supervisory/statutory basis for calculation of assets and liabilities - limits the insurer's ability to manipulate the amount of reserves/taxable profits * Unfair to ICs to use reserves in tax computation which are calculated less prudently than supervisory reserving basis - Pay tax on profits before they have been earned if tax assessment based on smaller reserves * Profits distributed to PHs on with-profits policies may be excluded from profit calculation - PH bonuses increasing liabilities would be excluded and cash bonuses paid out to PHs reduce end of year figure

Question 35

Describe the investment approach to taxation of a LIC.

Answer 35

* Taxes company as if it is a group of individuals pooling their money for investment within the insurer * Tax payable on investment income less some/all operating expenses of the company

Question 36

What is the effect of the fiscal regime?

Answer 36

Different types of LI business may be taxed by different methods * This can mean lower costs for the consumer if certain forms of benefit can be offered as one type of business rather than another * Different tax treatment of different types of LI contract can make it cheaper to provide some benefits as one form of business rather than another * Different tax treatment of LI business and other forms of saving may create opportunities for a life insurer but may also impose restrictions on contract design

Question 37

What should be considered when comparing the tax advantages of different products?

Answer 37

* Tax treatment of premiums paid * Tax on life insurer's funds during period of the contract * Tax treatment of eventual policy benefits

Question 38

What is taxation risk?

Answer 38

The risk that taxation can change over time and causing the company to make less profit than anticipated.

Question 39

What are significant drivers of product design?

Answer 39

The regulatory and tax environments.

Question 40

What is the purpose of actuarial associations giving professional guidance to actuaries?

Answer 40

* It will give actuaries a framework of points to consider in carrying out their responsibilities in order to maintain professional standards * Targets areas of judgement for the actuary * Strengthens statutory actuary's hand in discussions with management

Question 41

What is the aim of actuarial associations issuing professional guidance on interpretations of government regulations?

Answer 41

To generate consumer confidence and create a thriving life insurance industry for benefit of consumers and providers.