Chapter 20 - Product design

Question 1

State key consideration with regards to profitability

Product Design

Answer 1

• Premiums charged sufficient to cover benefits, expenses and provide profit margin.
  This will depend on the volume of sales achieved as well as the per policy premium/charging rates.

With regards to the 3 dimensions:
* Protection: mortality basis should cover risk involved, risk will gradually change and future chance should be allowed for if appropriate

• Savings: profit on investment income
• Administration: expense loading cover marginal/admin costs incurred, allowing for cross subsidies

Question 2

Areas of product design important for marketability

Answer 2

• Innovative design (features make contract more attractive)
• Attractive benefits (understandable to market and appreciated by them)
• Attractive charging structure (for UL + consideration of guaranteed charges)
• Guarantees and options (premium rates or structure)
• Distribution channel
  +impacts complexity of product which can be sold
  +if using multiple channels, will same price be used?

Question 3

Comment on financing requirements in product design

Answer 3

Unless company has substantial capital resources, will want benefits/charges to be designed to minimise financing requirement.

• UL advantages over non-linked contracts
  +no/few expense guarantees
  +no/few mortality guarantees
  +no/few investment return guarantees
  +smaller supervisory solvency margin requirement
• Reduce strain on non-linked contract
  +reduce initial acquisition costs (commission)
  +reduce initial administration costs
  +reduce valuation strain (increase val interest rate, reduce guarantees)
  +financial reinsurance

Question 4

Comment on risk characteristics in product design

Answer 4

Level of risk may be acceptable depends on insurer ability/willingness to absorb risk internally or re-insure

• Mortality risk
  well studied and quantified risk, this easy to absorb risk, unless entering new market for that company
• Company can do the follwoing for large parameter risk:
  +unit-linked/review-able form contract ( to avoid long term rate guarantee)
  +re-insure large part of risk
  +incorporate very ample margin in premium rate
  +offer is rider rather than standalone

Question 5

Comment on onerousness of guarantees in product design

Answer 5

• Problems
  +suffer a cost that you did not fully expect
  +reserve for loss possibility, increasing capital strain
• Guaranteed surrender value
  +generousness scale will be measure by reference to asset share
  +onerousness can be quantified as their impact on product design on profitability under various scenarios
• Investment return guarantee
  for without profits non-linked business
• Onerousness depends on
  +size (how much guaranteed)
  +period of time for which it holds
  +significance of reserves (for the contract)
  +volume of business to which it applies
  +capital available to company ( to absorb initial reserving cost/eventual real cost)

Question 6

Comment on the sensitivity of profit in product design

Answer 6

Mostly an issue for non-linked contracts, as under unit-linked, possible to have well-matched charging structure which reduces profit sensitivity to AvE

Variables that impinge on profitability:

• investment return
• mortality (or other contingencies, e.g. morbidity, longevity)
• expenses
• expense inflation
• persist-ency

Minimise sensitivity by:

• investment return (if there are no investment guarantees)
• mortality (make charge for this variable, at company’s discretion)
• expenses (make charge for this variable, at company’s discretion)
• withdrawal rates (don’t offer surrender/guaranteed values)
• matching (try to match income (charges) with outgo (expenses/benefit cost) as closely as possible by duration
• Redesign non linked products
  to reduce profit sensitivity
  e.g. commission claw-back to reduce sensitivity to withdrawal