Chapter 21 - Pricing: Other Considerations

Question 1

What is profit signature?

Answer 1

Profit signature of a contract is the sequence of profits over time from inception to termination

Question 2

Profit criterion that can be used (3)

Answer 2

1. Net present value
2. Internal rate of return
3. Discounted payback period

Question 3

What is internal rate of return?

Answer 3

The rate of return at which the discounted value of the cashflow is zero (higher rate of return is better)

Question 4

Why is Net Present Value more reliable than internal rate of return? (3)

Answer 4

1. If there is more than 1 change of sign in the stream of profits in the profit signature, there is not generally a unique IRR
2. NPV van be related to useful indicators of policy’s eorth to company such ito sales effort or market share. No way to do this with IRR
3. If a policy makes proftis from outset thw IRR may not even exist. The NPV exists however

Question 5

What is discounted payback period?

Answer 5

It is the policy duration at which the profits that have emerged so far have present value zero, ie it is the time it takes for the company to recover its initial investment with interest at the risk discount rate

Question 6

When considering premiums marketability, it might lead to a reconsideration of: (4)

Answer 6

• design of the product, remove features that increase riskiness or include features that will differentiate product
• distribution channel to be used
• company’s profit requirement
• whether to proceed with marketing the product

Question 7

Impact of competitor pricing on the insurer depends on the: (5)

Answer 7

1. Market structure
2. Sales channel
3. Features of the product
4. Availability of comparison quotes
5. Other features of the market

Question 8

The role of reinsurance in management of product development and profitability: (7)

Answer 8

1. Technical assistance
2. Risk sharing and limiting overall exposure
3. Smoothing prifitability
4. Providing financing to support new business strain
5. Tax arbitrage, where reinsurer is taxed in different basis from insurer
6. Solvency capital arbitrage, where insurer us reuired to hold less capital per unit of risk
7. Enabling insurer to accept larger risks

Question 9

Advantages and disadvantages of leaving it to market forces to keep HC insurance prices at reasonable levels

Answer 9

• high prices may result if industry organises cartels that keep prices at artificially high levels
• low prices may result if market forces drive price down, resulting in poor standard of insurance or threat of insolvency of insurer
• if left to themselves, IC may opt not to sell certain lines of business
• popular products likely to be more keenly priced than less popular ones, so customer with minority needs will have to pay more
• changes in market structure can quickly change the competitive effectiveness of a market

+ competitive market can lead to better value for money for customers
+ complying with regulation incurs costs, possible to pass coat savings to PHs
+ market driven prices allow companies to react much more swiftly to relevant changes in experience

Question 10

What is profit criterion?

Answer 10

It is a single figure that tries to summarise the relative efficiency of contracts with different profit signatures