Chapter 21 - Pricing (3) - Other considerations

Question 1

What are the profit criteria that can be used to determine the efficiency of contracts

Answer 1

• NPV
• IRR
• DPP

Question 2

What is net present value

Answer 2

discounting the profit signature at the risk discount rate produces a NPV

Question 3

What is profit signature

Answer 3

It is the sequence of profits over time from inception to termination

Question 4

What is IRR

Answer 4

It is the rate of return at which the discounted value of the cashflow is zero

All other things being equal, a company should prefer a contract that has a higher internal rate of return

Question 5

What is DPP

Answer 5

It is the policy duration at which the profits that have emerged so far have a present value of zero.

I.e it is the time it takes for the company to recover its initial investment with interest at the risk discount rate

The DPP ignores completely all the cashflows after the DPP

Question 6

What might a company reconsider to make the premiums charged more marketable

Answer 6

• The DESIGN of the product, either remove features that increase the riskiness of the net cashflows, or to include features that will differentiate the product from those of competing companies.
• The DISTRIBUTION channel used, if that would permit either a revision of the assumptions to be used in the model, or a higher premium to be used without loss of marketability
• The company’s PROFIT requirement
• Whether to PROCEED with marketing the product

Question 7

What needs to be considered in terms of competition premium rates

Answer 7

• The level of premiums charged compared with competitors, and
• The number and accuracy of rating factors involved

Question 8

On what does the impact of competitor pricing on the insurer depend on

Answer 8

FOAMS

• FEATURES of the product
• OTHER features of the market
• AVAILABILITY of comparison quotes
• MARKET structure
• SALES channels

Question 9

What cost of capital needs to be charged to policies. ie. added to premiums?

Answer 9

• Regulatory reserves
• Solvency capital requirements

Question 10

How can solvency capital requirements be reduced

Answer 10

By using Reinsurance arrangments.

Pure reinsurers may have lower solvency capital requirements than direct writers, and as such, the higher the proportion reinsured, the lower the total solvency capital requirement

Question 11

Benefits of Reinsurance

Answer 11

FARTS So Loud

• Providing FINANCING to support new business strain
• Tax ARBITRAGE where the reinsurer is taxed based on a different basis from the insurer
• RISK sharing and limiting overall exposure
• TECHNICAL assistance in data provision and pricing basis
• SMOOTHING profitability
• SOLVENCY capital arbitrage where the reinsurer is required to hold less capital per unit risk
• Enabling the insurer to accept LARGER risks

Question 12

How may regulators affect pricing

Answer 12

RSI S

• Restrictions on premium increases
• Submit calculations to the supervisory authority before the policies can be marketed
• Inability to differentiate between risk cells (eg by gender)
• Single premium costs to all new members ( community rating)

Question 13

What will the size of reserves depend on when premiums are undercharged

Answer 13

• The speed at which the premium can be reviewed ( and its size upgraded to the full rate)
• The likelihood that policyholders will renew their contracts as the premium level is being increased

Question 14

Why is NPV more reliable than IRR

Answer 14

• If there is more than one change of sign in the stream of profits in the profit signature, there is no unique IRR
• the NPV can be related to useful indicators of the policys’ worth to the company, in terms of sales effort or market share. There is no way to do this with the IRR
• If a policy makes profit from the outset then the IRR may not even exist. The NPV always exists