Chapter 17-Actuarial Funding

Question 1

What is actuarial funding? (4)

Answer 1

In the context of unit linked contracts, actuarial funding is when the insurer takes credit for some of the extra future annual management charges in present day’s terms.

Life insurers can hold lower reserves for unit-linked contracts (i.e. less units) to which it can be applied, and this reduce new business strain

Money saved can be used to cover initial expenses.

Missing unit funds then bought later on from future management charges and management charge should thus be greater than the actual fund management expenses.

Question 2

What are the requirements necessary for actuarial funding to work? (5)

Answer 2

Permitted by regulation

Benefit contingent on death/survival
+​for minimum period of years, thus still some risk on death

Unit related charge
+company hold less than full funded value
+additional units purchased over lifetime (using unit related charges)
+unit charge exactly sufficient (because charge is unit related, irrespective of any price movement)

Sufficient regular fund management charges
Specifically higher than management expenses.

Unit-linked related surrender penalty
​+imposed such that unit reserve not lower than surrender value payable

Question 3

What common mechanisms can be used to implement actuarial funding? (2)

Answer 3

Higher fund management charges on all units

Capital/accumulation units (with different management charges)

Capital units: attracts higher management charge, typically allocated premiums used to buy during first few years

Accumulation units: lower management charge, allocated premiums used to buy later on

However, has issues with transparency:
thus no longer really used in contract design

But because of long term nature, still many policies in force

Question 4

Actuarial funding factors

Answer 4

For endowment assurance at policy duration t allowing for contingency of death would be (using a suitably chosen basis):

UFt * A(x+t:n-t), where
UFt is the fully funded value of the unit fund at policy duration t
x is the entry age
n is the policy term

Discount rate used should be proportion of fund management charge we wish to take advance credit for
considering the ability to cover renewal expenses

Question 5

What is the effect of actuarial funding on net cashflows from the unit fund? (5)

Answer 5

Creates extra cashflows to non-unit fund (funding factor)
+to help reduce new business strains

+net cashflow reduces since assurance factor increases with time

Reduces future management charges

+transferred from unit fund to non-unit fund, coz charge is only levied on actual number of units purchase (which will now be less)

Additional charges/reduced credits
to non-unit fund will be much smaller than the additional credit as result of actuarial funding, providing AMC on units in unit fund is substantial

Creates additional liability on death
+on non-unit fund, due to death of policyholder because higher amount required to make up bid value of unit fund to guaranteed minimum sum assured
+this expected additional death cost is a charge on non-unit fund at each year end

Swap high future management charges for capitalised sum early
+thus matched cash flows from policy with incidence of expenses

Question 6

Considerations to consider when applying actuarial funding? (2)

Answer 6

Only allow for excess management charges
In the calculation of non-unit reserves

+Only residual cash flows from the unit fund can be counted towards future cashflow projections

+Full fund management charge is no longer available for this purpose

The unit fund should not be less than the surrender value

+thus, the extent to which actuarial funding may be employed is restricted by the amount of any surrender penalty (reduction in benefit from bid value of units) that company may impose.

+too risky to deduct the cost of additional benefit on surrender, coz surrender is policy option, it is quite feasible for all policies to surrender over a very short period of time.

+would then have to find value of units almost immediately, and there’d be inadequate reserves

Question 7

Advantages of actuarial funding? (7)

Answer 7

Lower reserves

Reduce new business strain

Write more new business

More capital efficient

Charges/expenses well-matched, while also…

…allowing higher initial allocation
making product more marketable t

Reduced investment/persistence risk
because charges/expenses more closely matched

Question 8

Disadvantages of actuarial funding? (5)

Answer 8

Regulatory restrictions

Can be complicated
particularly when used together with capital units

Issues because of complexity
+reduced transparency
+poor persistency because of selling to clients who don’t understand
+restricts distribution channels
+more effort required to sell
may restrict level of sales, +depending on remuneration

Requires surrender penalty
which may be unattractive

Increase mortality risk
As sum at risk will be higher due to greater discrepancy between reserves held and face value of units