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

Answer 3

• 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 4

Advantages of actuarial funding? (7)

Answer 4

• 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 5

Disadvantages of actuarial funding? (5)

Answer 5

• 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