Chapter 2: WLA & TA

Question 1

Whole life assurance (WLA)

Answer 1

has no fixed term and pays out when the policyholder dies.
It is most useful for meeting payments that may arise on death

E.G.
Funeral expenses or inheritance tax, or
for transferring wealth between generations

Question 2

WLA: Risks

Answer 2

Mortality and investment risks are both significant for the non-linked versions of the contract, although how important they are varies by age at entry and duration in force.

Withdrawals and expense inflation are also risks

Question 3

WLA: Capital requirements (5)

Answer 3

Similar to endowments and may be significant.

• the contract design (in particular the size of reserves that the design requires)
• premium payment frequency (in particular whether single or regular premium)
• the relationship between the pricing and supervisory reserving bases
• the additional solvency capital requirements
• the level of initial expenses.

Question 4

Term assurance (TA)

Answer 4

This provides a benefit on death within a specified term.
The payment might be a lump sum or an income for a specified period.
Typically not benefit is available on surrender

Question 5

Decreasing TA

Answer 5

If the income is for the outstanding term of the contract, the contract is effectively a form of decreasing term assurance.

A decreasing term assurance could also take the form of a lump sum, for example to pay off the balance of a loan

Question 6

TA: Risks

Answer 6

Main risk: worse-than-expected mortality experience

Withdrawals and expenses also present risks of loss

significant risk from selective withdrawal.

Renewal (especially) and convertible options increases anti-selection risks.

Question 7

TA: Renewal or convertible

Answer 7

Contracts may contain options to renew at the end of the term, or convert to a whole life or endowment assurance contract, on guaranteed terms.

Question 8

TA: Capital requirements

Answer 8

may be high depending on:
* the supervisory reserving requirements
* solvency margin requirements

Question 9

WLA: Without-profit

Answer 9

offer a guaranteed sum assured on death

Question 10

WLA: With-profit

Answer 10

the initial benefits may be increased by bonuses, or cash refunds may be given

Question 11

WLA: Risks (2)

Answer 11

relative and absolute significance of the investment and mortality risks depend on:
* the age at entry
* the duration in force of the contract

Question 12

WLA: Selective withdrawal

Answer 12

It is actually a form of anti-selection;

that is, where the actions of individuals (policyholders) adversely affect the financial condition of the company.)

The risk of selective withdrawals is not unique to whole life contracts.
The risk can be important for any contract offering high levels of protection.

Question 13

WLA: Anti-selection risk

Answer 13

The risk that those who take out the policy are the ones who “expect” to have heavier than average mortality.

Without underwriting, the insurance company would suffer earlier claims, on average, resulting in lower profits.

Question 14

WLA: Expense risk

Answer 14

The effects of inflation with regard to:
* the expense loadings in the premium payable
* the size of the premium itself

can lead to a significant expense risk for contracts of long duration in force.

Level premiums = product exposed to inflation far into an unpredictable future.

Question 15

WLA: Withdrawal risk

Answer 15

At times when the asset share is negative, there is a financial risk from withdrawals.

At other times, whether there is such a risk depends on how any withdrawal benefit paid compares with the asset share.

Question 16

Asset shares under (level) term assurances tend to be positive for roughly the final two-thirds or three-quarters of the policy term.

How can the company justify not paying out at least some of this asset share when a policy withdraws at later durations?

Answer 16

The following are possible reasons:
● The company will have made a loss on early withdrawals where the asset share would have been negative, often substantially so. So the company feels justified in recouping some of these withdrawal losses by making profits from later withdrawals.
● There will be a significant selective withdrawal effect. The retained asset share can then go towards meeting the increased costs due to the higher average mortality of the remaining insured lives.
● Asset shares are never very large on a term assurance contract, and payment of very small surrender values would not justify the cost of administering them.
Term assurance asset shares will tend to be quite volatile (fluctuating with claims experience each year), making any fair scale of surrender values equally volatile. This could seriously upset policyholders.
● Even at later durations asset shares are not always positive – eg where the policy is loss-making.

Question 17

Decreasing TA: Withdrawal risk (lapse and re-entry problem)

Answer 17

can be avoided by limiting the term over which premiums are paid (which of course increases the regular premium payable).
=> reduces the period over which the asset share is negative,
=> would be designed to produce positive asset shares (and hence profits) at a much earlier point in the policy term.

Hence this one product design feature reduces two aspects of the withdrawal risk: * it reduces the amount of loss on withdrawal (by increasing the asset share)
* it reduces the incidence of withdrawal (by removing the financial incentive).

Question 18

TA: Capital requirements

Answer 18

The intrinsic capital requirements of term assurance contracts are relatively small,

Some jurisdictions (E.G.) European Union (EU) countries - solvency margin requirements may effectively lead to a significant requirement.

Question 19

Level of prudence in reserving bases vs solvency margin requirements

Answer 19

inverse relationship

Question 20

Renewable/Convertible TA: Group contracts?

Answer 20

There would not seem to be a need for a group form of these contracts, other than a continuation option following cessation of employment.

A continuation option:

allows employees leaving an employer (and hence leaving a group contract) to take out an individual policy without medical underwriting.
The policy is usually a whole life or endowment assurance.

Question 21

Renewable/Convertible TA: Risks?

Answer 21

The existence of the option to convert or renew gives rise to a significant additional anti-selection risk at the date of exercise.

Question 22

Renewable/Convertible TA: Risks?

Answer 22

The option to renew poses the greatest risk, because the term assurance offers the greater incentive for anti-selection.

Question 23

Renewable/Convertible TA: Capital requirements?

Answer 23

Capital requirements may be higher than for a basic term assurance, depending on the extent of any additional reserve required.