CHapter 23 - Contract design factors

Question 1

List 18 factors to consider when designing or redesigning a contract

Answer 1

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-)

Question 2

List the 7 key parties involved in contract design

Answer 2

ALPACAS

Actuaries
Lawyers
Providers of benefits
Accountants
Customers
Administrators
Shareholders / financial backers

Question 3

List the factors influencing the needs of the customer that will aid in the designing of a contract

Answer 3

CRAB

• The CAPACITY to pay
• The RISKS they need to be covered
• ATTITUDE to financial risk
• The BENEFITS that are needed at different times in the future

Question 4

Give examples of contract design features that make a contract more marketable

Answer 4

1. Guarantees, options and choices
2. A competitive (low) price
3. Transparency and simple to understand
4. Features that distinguish it from the competitors

Question 5

Give examples of options relating to premiums, benefits, the use of proceeds and any other options that might be offered as part of a contract design

Answer 5

1. Premium options:
   - waiver of premium

• option to increase / decrease premium
• option to choose / change premium frequency

2. Benefit options:
   - discontinuance
   - early or late or ill-health retirement
   - spouse’s benefits
   - rider benefits
   - option to protect a no-claims discount
3. Use of the contract proceeds:
   - choice of annuity provider
   - choice of hospital under health insurance
4. Other options:
   - option to renew / convert a term assurance without further underwriting

Question 6

What are the two main types of competitive pressures that needs to be taken into account when designing a contract?

Answer 6

• The price
• The product features

Question 7

What is the underlying principle to consider in setting discontinuance terms for an insurance company or benefit scheme?

Answer 7

FAIRNESS between:
- the policyholder or member who is leaving

• the remaining policyholders or members
• the provider of the benefits

Question 8

How does an insurance company decide on which contracts to offer discontinuance terms?

Answer 8

It will look at:
- market practice

• regulatory requirements
• the likelihood of selective withdrawals
• the difficulty and cost of assessing and implementing suitable terms

The insurer may also consider past practice.

Question 9

What are the two forms that discontinuance terms can be offered

Answer 9

• paid as a lump sum
• paid-up status, with no more premiums being payable

Question 10

Surrender benefit

Answer 10

The policy stops, there is no further cover and the policyholder receives a lump sum payment (the surrender value)

Question 11

Lapse

Answer 11

The policy stops, there is no further cover and usually no payment is made to the policyholder by the insurance company

Question 12

Paid-up

Answer 12

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.

Question 13

Main factors to consider in determining suitable discontinuance terms for an individual leaving a benefit scheme

Answer 13

1. Fairness between the leaving member and those staying
2. Whether the member want to stay in the scheme as a deferred member or take a transfer value to another scheme
3. The scheme’s funding level at the point of discontinuance
4. Regulation / legislation affecting discontinuance terms
5. Administration expenses of determining and implementing the terms
6. Ease of calculation and frequency of change if terms

Question 14

Define ‘new business strain’

Answer 14

New business strain is the shortfall that occurs when a contract is written.

It occurs when the initial expenses, the provisions and any solvency capital exceed the premium received.

New business strain results in a capital requirement (to finance the shortfall)

Question 15

List ways in which a contract could be designed in order to reduce new business strain

Answer 15

OUMA L

• Offer contracts with low statutory provisioning requirements
• Use single premiums rather than regular premiums
• Match charges with expenses, and keep charges variable
• Avoid options and guarantees
• Low initial expenses / commission

Question 16

List four methods of financing benefits

Answer 16

1. Pay as you go
2. Funding all the benefits in advance
3. Regular payments building up a fund
4. Paying an amount when the benefit event happens, for example purchasing an annuity at the point of retirement

Question 17

List items that the expense charges of an insurance company would be expected to cover

Answer 17

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

Question 18

Explain the significance of cross-subsidies within a class of business in relation to contract design

Answer 18

Cross-subsidies occur when certain policies contribute more to profit and overheads than other policies.

Where there are cross subsidies, the mix of business written becomes important!

If the actual mix is different to the expected mix, then profits may be higher / lower than expected