Chapter 33: Pricing and Financing Strategies Flashcards

1
Q

Cost of benefits

A

The amount that should theoretically be charged for them.

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2
Q

Premiums should be calculated as…

A

The value of benefits and expenses plus a contribution to profit.

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3
Q

Premiums/contributions should allow for… (12)

A
  • theoretical value of the BENEFITS to be provided
  • value of the EXPENSES that will be incurred
  • contribution to PROFIT

P - PROVISIONING bases

E - the use of EXPERIENCE RATING to adjust future premiums
R - REINSURANCE costs
O - OPTIONS and guarantees
T - TAX
I - INVESTMENT income
C - COMMISSION
- COST OF CAPITAL
- CONTINGENCY MARGINS
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4
Q

Price of benefits

A

The amount that can be charged under a particular set of market conditions and may be more or less than the cost.

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5
Q

3 Factors influencing the price

A
  • distribution channels employed
  • level of competition in the market
  • premium frequency
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6
Q

Main methods of financing benefits

A
  1. Pay-as-you-go (unfunded)
  2. FUNDED:
    - lump sum in advance
    - terminal funding
    - regular contributions
    - just-in-time funding
    - smoothed pay-as-you-go
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7
Q

2 Main factors affecting the cost of benefits

A
  • frequency of occurrence (affects the timing of the benefits)
  • severity (affects the amount of the benefits)
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8
Q

2 ways of viewing a product price

A
  • Factor a profit criterion into the pricing process, and thus calculate the resultant premium. Test whether the premium is acceptable in the market.
  • Input the desired premium into the pricing model and calculate the resultant profit. Test whether this is acceptable to the company.
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9
Q

4 Examples of distributions systems

A
  • independent intermediaries
  • tied agents
  • own sales force
  • direct marketing
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10
Q

Independent intermediaries

A

Individuals who select products for their clients from all or most of those available on the market.

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11
Q

Tied agents

A

Offer the products of one provider or a small number of providers.

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12
Q

“own sales force”

A

Usually employed by a particular provider to sell its products directly to the public.

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13
Q

Direct marketing

A

Press advertising, over the telephone, internet or mailshots.

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14
Q

Financing

A

A term used for putting a price on benefits payable on future contingent events, primarily in the context of benefit schemes.
The section looks at the timing (or incidence) of monies paid in, ie contributions.

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15
Q

Unfunded

A

Find the money to pay for the benefit as the benefit falls due.

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16
Q

Fundede

A

To some extent, the monies to meet the benefit costs are set aside before the benefits fall due.

17
Q

Terminal funding

A

Funds that are expected to be sufficient to meet the cost of a series of benefit tranches can be set up as soon as the first tranche becomes payable.

18
Q

Regular contributions

A

Funds are gradually built up to a level expected to be sufficient to meet the cost of the benefit, over the period between the promise being made and the benefit first becoming payable.

19
Q

Just-in-time funding

A

Funds that are expected to be sufficient to meet the cost of the benefit can be set up as soon as a risk arises in relation to the future financing of the benefits (eg bankruptcy or change in control).

20
Q

Smoothed PAYG

A

Funds that are set up to smooth the costs under a pay-as-you-go approach to allow for the effects of timing differences between contributions and benefits, short-term business cycles and long-term population changes.

21
Q

2 Reasons the actual contribution rate may be different from the calculated contribution rate

A
  • the assets held are higher or lower in value than the accrued liabilities and thus there is a surplus or a shortfall.
  • The sponsor may want to change the pace of funding of the scheme by paying a higher or a lower contribution in any year.
22
Q

3 Reasons for changes to the pace of funding

A
  • changes in the fortunes of the sponsor
  • the opportunity cost of the contributions and alternative investment opportunities
  • changes in view over the degree of caution / optimism required
23
Q

5 advantages of pay-as-you-go

A
  • allows benefits to be introduced at a worthwhile level in the early years as there is no need to wait for a fund to accumulate
  • involves lower transaction costs (there is no funding)
  • prevents funds from being tied up in the scheme
  • for State-operated schemes it can increase solidarity within the community
  • makes it easier to organise payment according to need with contributions according to ability to pay
24
Q

Why might a surplus arise? (3)

A
  • the assumptions about future experience were unduly pessimistic
  • the assumptions were reasonable but the experience turned out to be favourable
  • the sponsor paid more than the recommended contributions
25
Q

Why might the “price” of benefits be different from the cost? (3)

A
  • The provider’s distribution system may enable it to sell above the market price or take advantage of economies of scale
  • There may only be a limited number of providers in the market and so a higher premium might be charged.
  • The provider will also need to decide whether it is prepared to offer the business on a single premium basis or a regular premium basis or both. The provider may charge a higher regular premium in order to encourage policyholders to pay upfront.