Chapter 23: Contract Design Flashcards
List 18 factors to consider when designing or redesigning a contract
AMPLE DIRECT FACTORS
Administration systems Marketability Profitability Level and form of benefits Early leavers benefits
Discretionary benefits Interests and needs of customers Risk appetite of the parties involved Expenses vs charges Competition Terms and conditions of the contract
Financing (capital requirements) Accounting implications Consistency with other products Timing of contributions or premiums Options and guarantees Regulatory requirements Subsidies (cross-)
Outline the main administrative considerations that relate to contract design
These include:
1. whether to outsource the administration or perform it in-house
2. whether existing systems can carry out the functions that have been built into the product design
3. the need to produce a new or updated product literature
4. the cost of making systems and admin process changes
5. whether some of the changes can be deferred because they are not required at short policy durations - whilst bearing in mind the potential difficulty of scheduling these changes for a later time
Give examples of contract design features that make a contract more marketable
- Guarantees, options and choices
- A competitive (low) price
- Transparency and simple to understand
- Features that distinguish it from the competitors
List the factors influencing the needs of the provider
- The chosen market
- The capital available
- The expertise available
List the factors influencing the needs of the customer
- The capacity to pay
- The risks they need to be covered
- The benefits that are needed at different times in the future
- Attitude to financial risk
Give examples of how a contract can be designed to cater for different risk appetites amongst customers
- Different investment funds , e.g. low, medium and high risk
- Different levels of cover, e.g. comprehensive vs third party
List 8 items that the expense charges of an insurance company would be expected to cover
COST RAID
Commission
Overheads
Sales / advertising
Terminal, e.g. paying benefits
Renewal administration ,e.g. collecting premiums
Asset management
Initial administration
Design of the contract
What is the underlying principle to consider in setting discontinuance terms for an insurance company or benefit scheme?
FAIRNESS between:
- the policyholder or member who is leaving
- the remaining policyholders or members
- the provider of the benefits
Surrender
The policy stops, there is no further cover and the policyholder receives a lump sum payment (the surrender value)
Lapse
The policy stops, there is no further cover and usually no payment is made to the policyholder by the insurance company
Paid-up
The policyholder ceases to pay premiums but the policy continues to offer the policyholder some cover.
In this case the benefit is reduced to reflect that there are no more premiums and is called the paid-up value.
Withdrawal
This normally encompasses surrender and lapse, as the policy does not stay in force.
How does an insurance company decide on which contracts to offer discontinuance terms?
It will look at:
- market practice
- regulatory requirements
- anti-selection risk
- the difficulty and cost of assessing and implementing suitable terms
The insurer may also consider past practice.
Factors to consider when determining discontinuance terms
Fairness, hence the starting point will be the ‘asset share’ of the contract (a current value determined retrospectively from the accumulation of net cashflows)
Other factors include:
- PRE
- New business disclosure and any subsequent communications
- competition
- regulation / legislation affecting discontinuance terms
- administration expenses of determining and implementing the terms
- ease of calculation and frequency of change of terms
Main factors to consider in determining suitable discontinuance terms for an individual leaving a benefit scheme
- Fairness between the leaving member and those staying
- Whether the member want to stay in the scheme as a deferred member or take a transfer value to another scheme
- The scheme’s funding level at the point of discontinuance
- Regulation / legislation affecting discontinuance terms
- Administration expenses of determining and implementing the terms
- Ease of calculation and frequency of change if terms