Chapter 3- South African Specific Products (Individual Life)

Question 1

List various product categories of a Life insurer? (5)

Answer 1

• Risk products
• Investment Products
• Universal life products
• Annuity products
• Conventional with-profit

Question 2

Describe risk products and their common features? (11)

Answer 2

• Provides mainly risk cover
benefits are provided in case of a life event (death, disability, critical illness)

• Generally do not offer surrender or maturity benefits or include any savings element

• Features influenced by
o financial sophistication of policyholders and
o their access to financial advice

• Policy term – whole of life, specified term or until specific age
o Whole of life  no surrender value!

• Choice of disability and critical illness benefits – whether they want it and definition

• Standalone or accelerator (for disability and critical illness)
o Standalone: sold without a death benefit  no payment on death
o Accelerator: attached to a death benefit; if a CI claims occurs, the death benefit is reduced

• Premium frequency – recurring (monthly, quarterly or annual) rather than single premium

• Premium paying pattern – level or increasing

• Level of cover – choose within benefit limits

• Future cover option (Guarantee insurability options) – option to purchase cover in the future without proof of good health, except for an HIV test
o Exercise on benefit anniversary or specified events (marriage, birth of child, new mortgage)

• Products with limited underwriting (target low income segment): policyholder is not medically underwritten  limit anti-selection through waiting periods etc.

Question 3

Describe the risk applicable to risk products for an insurance company? (7)

Answer 3

• The primary risk is related to the accurately allowing for the incidence of the claim event in the pricing of the product
o An appropriate model allowing for correlations between conditions and illnesses, adequate data, additional risk margins, competitive premiums
o The current incidence rate may not be applicable in the long-term due to changes in medical science
o To the extent that disability may be linked to the economic cycles, there is a risk that there are changes in the economic cycle not allowed for premiums

• Anti-selection to weak underwriting procedures

• Weak claim definition may result in higher than expected claims

• Furthermore the claims management process may not be able to have the technical expertise to evaluate certain claims

• Reputational risk is the policyholder does not adequately understand the claim definition i.e. technical definition vs. layman understanding

• There is also withdrawal risk which may result in financial loss at early durations

• Furthermore the withdrawals may be selective which may result in worse morbidity experience for remaining policyholders

• There may be additional pricing and anti-selection if future cover options are availa

Question 4

List mitigation techniques to reduce risks from risk products for an insurance company? (7)

Answer 4

• Underwriting – depends on the level of cover, entry age, the complexity of benefit
• Waiting period
• Reviewable premium rates
• Age limits
• Clear disclosure, to mitigate reputational risk
• Reinsurance
• Retention incentives – eg cash back plans

Question 5

Describe premium paying patterns for risk products? (3 main, 8 sub)

Answer 5

• Level premium
o High initial premium – premium significantly larger than that required to cover the cost of risk in early years
o Pre-funding: excess premium (in early years) is invested to fund the cost of risk in later years when the premium is insufficient to cover the risk

• Compulsory premium growth
o Cheapest initial premium for a given cover level (benefit usually remain level)
o Increasing premium rates are priced into contract

• Voluntary premium growth
o Automatic increase in premiums and cover to compensate for inflation
o Policyholder can at any time switch off the voluntary premium growth without penalty
o May contain a guarantee (or reasonable benefit expectation) that rates (i.e. relationship between premium increase and cover increase) will be the same as for new business
o  anti-selection risk as better lives may switch off automatic increases and seek (cheaper) cover elsewhere

Question 6

Describe various premium reviews conditions included in risk products? (4)

Answer 6

• ASISA Code on Policy Quotations requires insurer to disclose the potential for premium reviews at time of sale
o Expect reviews –> disclose expected level of premiums
o Do not expect reviews –> disclose circumstances that would cause premium review

• Types of review:

o Yearly renewable policies – patterns above are not relevant as premiums can be reviewed and changed annually, used for most products with a simple design

o Premium reviews expected – increase at regular intervals (e.g. every 5 years)

o No premium reviews expected (but premiums only guaranteed for a limited period) – only review where actual experience is materially different to pricing assumptions

Question 7

Describe waiver of premium benefits available on risk products? (2)

Answer 7

• Waives the premiums of the policy in case of pre-specified event
o (disability, death, retrenchment of specified life insured
o Life insured covered under premium waiver can be different from the life insured covered under the main policy

Question 8

Describe Critical illness benefits as well as the characteristics for the inclusion of critical illness benefit? (7)

Answer 8

• Hybrid product – non-indemifying lump sum benefit payable when:
o Medical/CI Event (independent of extent)
o Reaching defined degree of impairment
o Undergoing surgery (surgical procedure)

• CI illness characteristics
o Perceived by public to be serious and occur frequently
 If not life threatening, at least lifestyle-threatening
o Clearly defined – no ambiguity
 Difficult – medical terminology
 Tiered benefits also make difficult
o Sufficient data for pricing
o Avoid anti-selection

Question 9

Describe the needs that critical illness products meet? (6)

Answer 9

• Income can be provided from the lump sum via the purchase of an annuity when the individual cannot work as a result of their condition
• Medical costs can be funded such as treatment or expensive surgery
• Payment of mortgage of loan in the event when the policyholders health is in question
• Business partners can purchase critical illness on the lives of each other such that benefits will fund the buyout
• Recuperations needs after the illness example the installation of specialist equipment in their home
• A change in the claimant’s lifestyle e.g. moving to a less stressful job after a heart attack

Question 10

Describe the problems and complications of critical illness products? (6)

Answer 10

• Claim Definitions (complex & differ between insurers)
o ASISA has introduced SCIDEP (Standardised Critical Illness Definitions Project) covering cancer, heart attack, stroke and CABG at four severity levels
o Insurers must disclose the extent to which their product definition is SCIDEP compliant

• Lack of transparency at claim stage due to:
o Exclusions
o Point-of-claim underwriting
o Actual condition covered (in policy) is more severe than the colloquial understanding of the term

• New diseases  must manage expectations of policyholders and distributors
o Include these at little or no extra cost in a “catch-all” condition for which policyholder can only claim once
o Difficult to allow in pricing  reinsurer assistance

• Medical advances unpredictable
o Trends in incidence for different for each different CI moving in diff directions  future product incidence rates difficult to predict

• Windfalls where lump sum exceeds the immediate medical costs or longer term loss in quality of life (but difficult to quantify)  potential moral hazard

• Standalone  death benefit is not priced into the product  insurer must manage risk of paying a claim if the policyholder dies soon after the CI event
o Policyholder must at least survive the survival period (usually 14 days)

Question 11

Describe Permanent Disability Insurance? (3)

Answer 11

A lump sum non-indemifying benefit on a trigger event that can be:

• Occupational based
• Activities of daily living/activities of daily working
• Functional impairment and physical impairment

The cost of disability cover will depend on the definition of disability used

Question 12

Describe occupational based disability definitions?

Answer 12

Disability is established by the inability to carry out an occupation. This could relate to the inability to perform:
• Own occupation (not suitable where skills can easily be impaired)
• Similar occupations for which insured is suited that are incorporate the qualification (education), status and skills (training and experience)
• Any occupation

Question 13

Describe ADL based definitions? (6)

Answer 13

•The inability to perform a number of everyday tasks without assistance

ADLs as per ASISA standard critical illness definitions projects (SCIDEP) defs: feeding, dressing, washing, toileting, mobility, transfer

• Applicable to wider range of lives
o Including after retirement and self-employed
• Less subjective
• Only use one definition throughout policy term
• Products often don’t use ADLs as only claim criteria
o ADL & ADW defs serve as underpin for disability and CI products

Question 14

Describe physical or functional impairment definitions? (7)

Answer 14

Physical impairment are usually clearly defined in policy documentation
e.g. loss of one or more limbs,
extremities and senses,
burns,
permanent confinement to bed or wheelchair,
facial disfigurement
or amputation.

Functional impairment is more expensive and also makes use of the ADLs.

Question 15

Describe Income protection products (8)

Answer 15

Income protection products also known as permanent health insurance (PHI) products replace the income that the insured with have earned if he/she become unable to work due to accident or illness (i.e. incapacity).

The benefit will be payable in the form of an annuity with payments ceasing on recovery, death or expiry of the policy.

The payments of benefits does not terminate the policy. Income protection will cover both temporary and permanent disability.

The claim definition will exclude:
• Early retirement
• Unemployment
• Injury caused by alcohol or drug abuse
• Self-inflicted injury/ attempted suicide
• Criminal activity
• War
• Not following medical advice

IP products are sold with a waiting period/deferred period i.e. the amount of time that the insured has to be fully or partially disabled before they receive benefit payments. The waiting period can range from 7 days to 2 years

A policy may also include a linked claims period or “off period” which waivers the waiting period for a specified duration after a claim.

The benefit may be level or escalating with may be fixed or in line with inflation. The rate of escalation may be different inside and outside the claim period.

IP products also provide rehabilitation or proportion benefits to those who can work on a part time basis or in a less strenuous role.

Question 16

Describe the regular benefit limitations on the replacement ratio for Income protection products? (2)

Answer 16

Benefit limits are applied (across all IP polices taken out by policyholder) to ensure that the insured has incentive to return to work:

• For the first two years of incapacity the benefit amount will not exceed 100% of the insured pre-claim income
• Thereafter the benefit amount will not exceed 75% of pre-claim income however if a condition is deemed permanent then the limit will remain at 100% of the insured pre-claim income

These benefits are applied across all IP policies that a policyholder has taken out to reduce overinsurance.

Question 17

Describe the risk associated with Income Protection products to the life insurance company? (3)

Answer 17

• There is significant morbidity risk which could either refer to higher claim inceptions than expected and fewer termination/recoveries than expected

• Underwriting, claims management and administration are more complex than other products which results in additional anti-selection and expense risk

• There is also the risk of moral hazard i.e. the insured may not notify the insurer of their recovery and it is difficult to monitor individual cases

Question 18

Describe Key person insurance? (3)

Answer 18

• Employer-owned policies to protect the employer against financial loss in the event of death, disability or severe illness of a key individual

• Tax treatment of employer-owned policies can be complex
o  actuary need to consult a tax expert when designing these policies

• Additional risk to insurer: early terminations where key employee leaves company (but underlying reason different to lapses of other risk products – need to feed this into assumptions)

Question 19

Describe the needs met by key person insurance? (6)

Answer 19

• Financial loss consists of additional expenses as well as loss in profitability, due to having to:
o Find suitable replacement
o Up-skill another employee
o Change the business model
o Wind up the business

• Settle the loan account (in the business) of the director or owner
• Fund buy out of the shareholding of the diseased partner

Question 20

Describe Credit life insurance? (6)

Answer 20

• Borrower are often required to have a policy covering the outstanding amount of the loan (e.g. purchase of consumer goods) over the repayment period
o To reduce risk of default if borrower were to die or become disabled

• Often include loss of income, retrenchment benefits and disability cover
• Sold in large quantities in the micro-loan industry
• Premiums (single or recurring) for terms of 3 months to 5 years
• NCA has disallowed the adding of the single premium to the initial loan (to be repaid in instalments)

Question 21

Describe the risk to the insurer associated with credit life insurance? (5)

Answer 21

• Underwriting very limited BUT - Anti-selection risk is not as material since
o the life policy is secondary to an application for finance ( not a primary purchase)
o Pre-existing conditions excluded (mostly)
o Sum assureds relatively small

• Early loan repayments is a risk where policy has level premium payments for the full term
o  decreasing SA (early cover is funded towards the end of the policy)

• Cross-subsidisation of premiums within age bands

• Profit share arrangements with finance provider  Insurer may be forced to pay excessive amounts of profits (following profit share negotiations) to retain the business

• Reputational risk – reduced by introduction of credit life insurance regulations

Question 22

Describe the impact of National credit Act on credit life policy premium, cover and exclusions? (5)

Answer 22

• Effective from august 2017
• Max charges (R2.00-R4.50 per R1000 per month)
• Min benefits
o Dies/ permanently disabled  outstanding balance paid out
o Loses job/ permanently disabled  pay instalments up to 12 months
o Not employed at commencement  can’t be charged for retrenchment cover
• Limitations and exclusions to be applied e.g. maximum waiting periods, early retirement

Question 23

Describe funeral assurance? (8)

Answer 23

• Provides an amount of money in the event of death of the policyholder and members of her family  usually sold as term assurances
• Sophisticated and expensive funerals is part of South African culture
• Extended family members can be added to the policy for an additional premium
• Sum assureds are relatively small – but must be paid over quickly after death is notified
• Simple, with little or no underwriting
o If underwriting done, max SA higher and cost lower
• Short waiting periods (<6m) where only accidental death is covered
• Optional tombstone benefit – will be paid out up to one year after the death to cover the cost of the tombstone
• “Assistance business” according to Long-term Insurance Act
o Maximum sum assured of R100 000 increasing at CPI according to the Insurance Act 2017
o Not subject to commission restrictions

Question 24

Describe the risks associated with funeral assurance? (4)

Answer 24

• Moral hazard – as there is no limit on the number of policies to be taken on a single life, particularly children
o  Long-term Insurance Act imposes a limit on the aggregate across all life and assistance policies on the life of child
 (R10,000 if younger than 6 & R30,000 if younger than 14)

• Fraud – as claims must be paid very quickly

• Mortality underestimated – especially with regard to AIDS

• Maintenance and premium collection expenses higher than expected – especially as these represent a large percentage of (small) premium
o Mitigate by having reviewable premium rates

Question 25

Describe investment products of life insurance companies? (3)

Answer 25

• Act mainly as savings vehicles  maturity and surrender benefits are integral to the product

• Investment products sold under a life license  mainly two types:
o Endowments – usually unit-linked endowments in RSA, where the death benefit is equal to the unit fund
o Retirement annuities

• Policyholders can usually choose type of underlying portfolio:
o Market-linked, with or without (various) investment guarantees
o Smooth bonus
o Guaranteed product

Question 26

Describe unit fund in the context of investment products? (4)

Answer 26

• Applicable to market-linked and smooth bonus portfolios

• Represents policyholder’s basic benefit at any given time

• On a regular basis, the insurer will either do a fund value build-up or a number of units build-up for every client
o Fund value build-up:
 Market-linked: based on actual returns
 Smooth bonus: based on declared bonuses
o Units build up: actual returns or bonuses declared are allowed for in unit price

• Actual benefit paid on maturity / surrender / transfer / death is based on the unit fund adjusted for any guarantees or charges (e.g. surrender penalties)

Question 27

Describe common contract features of investment products? (5)

Answer 27

• Policy term –
o Endowment – ph chooses term, at least five years
o Retirement annuity – function of chosen retirement age
o after expiry of initial policy term, the investment may be continued (with surrender penalties falling away)

• Premium frequency – single or recurring
o Premium growth is always voluntary for investment policies (i.e. no penalty for switching off premium growth)

• Premium size – can be chosen by the policyholder subject to certain minimums

• Paid-up policies possible

• Premium waiver possible

Question 28

Describe the disclosure requirements of effective annual costs? (4)

Answer 28

• To promote TCF – ASISA developed a standardised disclosure methodology of the charges an investor will incur

• Allow investors to compare charges and their impact on investment returns
o Across various financial products and regulatory wrappers

• Investors can make more informed decisions

• Charges shown as annualised % and split into 4 categories
o Investment, advice, admin and other

Question 29

Describe risk associated with investment products for life insurance company?

Answer 29

• Market risk (except for market-linked WITHOUT guarantees)  asset values can fall below the actuarial value of liabilities. Limit risk by:
o Matching assets to liabilities by nature
o For smooth bonus: market value adjusters, choice of assets,
management of bonus stabilisation reserves

• Expense risk – where actual costs exceed the charges

• Withdrawal risk – where the asset share is less than withdrawal benefit

Question 30

Describe retirement annuities? (7)

Answer 30

• Retirement fund where maturity value is used to purchase immediate annuity
• RA fund is a retirement fund other than a pension or provident fund, used to provide for retirement and/or death benefits to individuals and their dependents
• Established as a scheme with a board of trustees and a set of rules
• Benefits are usually purchased from a life insurer, which also administers the fund
• Benefits may not be ceded or assigned, nor cash surrender benefits paid out – only transfers to another RA provider
• Paid-up policy would be granted on early cessation of contributions if policy has acquired a value
• Tax benefits

Question 31

Describe the customer needs satisfied by retirement annuities? (6)

Answer 31

• Retirement income
• Lump sum at retirement (commute up to one third of retirement income)
• Guaranteed annuity option (possibly) – to convert maturity proceeds into a life annuity at guaranteed terms
• Death benefits (possibly)
• Disability benefits (possibly)
• Favourable tax treatment (deductable premiums as well as portion of lump sum benefit is tax free)

Question 32

Describe deferred compensation schemes? (5)

Answer 32

• Employer-owned policies purchased by employers to reward key individuals whose services the employer wishes to retain

• Benefit to employee depends on exact structure of policy & arrangements with employer
o Typically: endowment on life of employee, with the employer paying the premiums

• Proceeds are paid to employer, who pays this over to employee in terms of the arrangement

o Cash benefits also payable to employee or his dependants on earlier death / disability

• Tax treatment of employer-owned policies may be complex (amended ITA in 2010)
o Consider from point of view of employer and employee

• Structural bases: unit-linked, smoothed bonus or with-profits policy

Question 33

Describe universal life products? (9)

Answer 33

• Combines risk cover and investment

• Sold in 80s and 90s – but now stopped mostly
o Lack of transparency – combination of risk cover and savings elements makes it difficult for the policyholder to assess the amount paid for the risk benefit and to compare investment returns with other savings vehicles
o Trend is towards pure risk or investment products (“unbundled” policies)

• Intention (at that time): greater flexibility of premium relative to sum assured (with the balance of premium contributing towards investment) – when compared to traditional life policies

• Cost of cover
o = [actual sum at risk] * [rate for the one-month risk]
o regularly calculated

• Cost of cover (+ expenses levied) is deducted from the premium paid and the balance (positive or negative) is invested in the unitised portfolio(s) selected by the policyholder

• Unitised portfolio can be market-linked or smooth bonus

• Sum assured & premium – chosen independently
o subject to
 overall maximums and minimums
 any additional underwriting requirements

• Can also be RAs with cover
o Tax treatment like other RAs

• Universal life can be seen as unit linked version of
o Whole life assurance with surrender value
o Endowments with significant death benefit

Question 34

Describe the risks faced by life insurance company on universal life products? (3)

Answer 34

• Main risk: sum assured selected or return on the investment portfolio results in a negative monthly investment  eliminates investment component of policy
o Premiums insufficient for risk cover  company bears the loss
o  impose maximum sum assured
o  retain right to increase premium on review dates

• Underwriting risks (e.g. mortality and disability) is reduced as the risk premium rates are generally not guaranteed
o BUT premium increases  possibility of negative investment

• Anti-selection – where sum assured can be increased
o  require evidence of good health

Question 35

Describe annuity products sold by life insurers? (4)

Answer 35

• Traditional with-profits / non-profits or Living annuities

• Four types of traditional annuities:
o Single life – payments while the policyholder is alive
o Joint life – payments while the policyholder or her spouse is alive
o Temporary annuity – payments while policyholder is alive within a specified term
o Term certain annuity – payments continue for a specified term, independent of whether the policyholder is alive or not

• [Compulsory] annuity – annuity purchased with the proceeds from a pension, provident or retirement annuity fund

• Single and joint life annuities can be sold with or without a guaranteed period.

Question 36

Describe living annuities (Equity linked life annuities)? (4)

Describe the risk to the insurer regarding living annuities? (3)

Answer 36

• Single premium after expense deductions is invested in a unitised portfolio, of which the unit price increases with growth and reinvested income
• Pensioner can select an income (drawdown) for any one year
o between 2.5% and 17.5% of the [remaining capital at the start of that year]
• Fund available on death can be used to purchase similar contract for spouse or dependants
• Pensioner accepts longevity risk and risk that portfolio does not perform as expected

Risks to insurer
• No mortality or interest rate risk to insurer
• Reputational risk for insurer (and insurance industry) as annuitants may run out of money
o  give [good advice] and ensure [clear disclosure]
o  most companies have their own restrictions on the maximum amount of annuity based on age at commencement and sex
• Expense risk
o charges are not adequate to cover the cost of administration

Question 37

Describe conventional with-profit annuities? (6)

Describe the risk to the insurer regarding these annuities? (3)

Answer 37

• Basic annuity income is guaranteed, and increased annually by bonus income declared  to help protect real value of income

• Different levels of income purchased  depending on level of bonus loading within premium rates

• Smoothing of bonuses to reduce volatility of return passed to annuitants

• Initial guaranteed income will be less than for conventional annuity, but annuity income (with bonuses) is excepted to exceed conventional annuity after a period
o Since aggressive investment policy (facilitated by: bonus loading contained within premium)

• Attractive to small pension and provident funds that do not wish to pay pensions ex-fund (ie directly out of fund assets)
o but have funded for retirement benefits related to members’ salary, allowing for pension increases after retirement

• Recently incorporated into insurance solutions to fund [post-retirement medical aid contribution liabilities]

Risks to insurer:

• Bonus loading and inclusion of emerging experience in bonus declarations (both positive and negative) reduces risk
• Longevity risk as declared bonuses cannot be removed
• Repuatational as the bonus declarations will need to be consistent with policyholder reasonable expectations

Question 38

Describe increasing without-profit annuities? (2,5)

Describe the risk to the insurer regarding these annuities? (2)

Answer 38

• Types of increases (in order of inflation protection guarantee and hence cost):
o Fixed %,
o CPI with fixed % cap,
o CPI,
o X% of CPI (proportional)
o CPI + fixed% (additive)
(higher cost of increase  lower regular income)
• Attractive due to high nominal interest rates (erosion of value)

Risks – non-profit increasing annuities:
• Reinvestment risk
o Impossible to match payments with ordinary fixed interest stock
o Interest payments exceed the annuity payments for a number of years

• Longevity risk increased (by virtue of increasing payments)

• Market risk for CPI-linked
o limited real assets available (potentially expensive and shorter duration than liabilities)  difficult to match CPI-linked annuities