Chapter 34: Discontinuance

Question 1

Overriding principle in determining discontinuance terms:

Answer 1

make sure they are fair to:

• the policyholder or scheme member
• other policyholders and scheme members
• the provider of the benefits

Question 2

4 Factors for the insurer to consider in relation to discontinuance are:

Answer 2

• contracts for which to offer discontinuance terms (as determined by market practice, regulation or complexity in calculating terms)
• form of discontinuance terms offered (eg lump sum or paid-up value)
• how it goes about setting discontinuance terms
• practical considerations relating to the discontinuance benefits

Question 3

In setting discontinuance benefits, a life insurer must take account of (7)

Answer 3

• the asset share of a policy (insurer’s perspective)
• policyholders’ reasonable expectations (p/h views)
• new business disclosure (lead the views of the p/h)
• competitive considerations (drive insurer to increase p/h expectations)
• the ease of calculation of the discontinuance benefits
• frequency of change of discontinuance terms
• the cost of implementing the discontinuance terms (subject to frequency of change)

Question 4

2 Reasons insurance companies rarely become insolvent

Answer 4

• a regulator typically regularly monitors the financial position of insurance companies
• insurance company regulation typically requires companies to hold a minimum level of solvency capital

Question 5

If the insurer’s financial position is serious, then the regulator may require the company to (2)

Answer 5

• close to new business,

- or establish a recovery plan

Question 6

Issues that need to be addressed and modelled w.r.t. future solvency position:

Answer 6

• estimation of future profits available to equity shareholders, net of tax
• the current value of all surplus assets
• the amount, and timing, of any loan or debt redemption
• outstanding financial obligations, minority interests, tax
• considerations relating to staff benefit schemes - particularly if schemes are in deficit
• problems of staff relationships (and redundancies)

Question 7

If there is an acquiring company prepared to take over the business, it is necessary to consider (4)

Answer 7

• the location of the operation
• the integration of the systems platform
• relocation of staff or whether there is an adequate labour force available
• the effect on unit costs

Question 8

A benefit scheme may cease due to (2)

Answer 8

• the insolvency of the sponsor

- a decision by the sponsor to stop financing benefit provision

Question 9

If a scheme ceases, the level of benefits that will be paid will be affected by (3)

Answer 9

• the rights of the beneficiaries
• the expectations of the beneficiaries
• the level of assets

Question 10

Procedures if - at time of discontinuance - the scheme is under-funded

Answer 10

• Consideration the priority of the different groups of members of the scheme in receiving benefits (current pensioners)
• This may be dictated by legislation or scheme rules.
• An allowance should be made for the expenses involved in determining the benefit allocations.

Question 11

Procedures if - at time of discontinuance - the scheme is over-funded

Answer 11

The surplus may pass back to the employer, or be used to improve the benefits of the scheme members.
Consideration must be given to ensuring that members’ basic rights are met before seeking to improve the benefits.

Question 12

If a benefit scheme is being discontinued, the following options may exist for the provision of the outstanding benefit payments (5)

Answer 12

• continuation of the scheme without any further accrual of benefits
• transfer of the liabilities to another scheme with the same sponsor
• transfer of the funds to the beneficiary to extinguish the liability.
• transfer the funds to an insurance company to invest and provide a benefit
• transfer the liabilities to a provider, eg insurer or central discontinuance fund who will guarantee to pay a specified level of benefits.

Question 13

4 possible definitions of “discontinuance”

Answer 13

• individual policyholders terminating an insurance contract
• individual members ceasing to accrue benefits in a benefit scheme
• an insurance company becoming insolvent
• a benefit scheme winding-up

Question 14

In a life insurance contract, discontinuance may mean (3)

Answer 14

• surrender
• lapse
• paid-up

Question 15

Surrender

Answer 15

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

Question 16

Lapse

Answer 16

The policy stops, there is no further cover and NO PAYMENT is made to the policyholder by the insurance company.

Question 17

Paid-up

Answer 17

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 18

Withdrawal

Answer 18

Encompasses both “surrender” and “lapse” in a life insurance context.
The implication is that the policy does not stay in force and therefore it has been withdrawn.

Question 19

Discontinuance in the context of a benefit scheme

Answer 19

Relates to an individual member moving from the active status to deferred status.
The member may decide to leave the accrued benefits in the scheme or transfer them elsewhere.

Question 20

Deferred status

Answer 20

Member has past benefit entitlement but accrues no further benefits.

Question 21

Winding-up

Answer 21

The process of terminating a scheme, usually by applying the assets to the purchase of individual insurance contracts for the beneficiaries or by transferring the assets and liabilities to another scheme.

Question 22

4 Things a life insurer should consider in setting discontinuance terms

Answer 22

• which contracts to offer discontinuance terms on
• the form of the benefits being offered
• how it goes about setting the discontinuance terms
• any practical considerations relating to the discontinuance

Question 23

The contracts on which the insurance company will offer discontinuance terms will be governed by (3)

Answer 23

• market practice
• regulatory requirements
• the difficulty of assessing suitable terms, eg the lump sum to pay on the discontinuance of an immediate annuity.

Question 24

3 Main components of the asset share

Answer 24

Accumulation of premiums with investment returns - expenses - cost of cover

(It’s a retrospective reserve)

Question 25

Cost of cover

Answer 25

The contribution the policy needs to make towards the claims arising on the portfolio of similar policies.
e.g. total claims paid out of term assurance divided by no of term assurance policies in force—> cost of over for individual term assurance policy

Question 26

Compensation schemes

Answer 26

Where an insurer cannot meet its liabilities (as opposed to not having adequate solvency capital), and a buyer cannot be found to take them on, there may be a statutory scheme set up from which some or all of the benefit payments are paid.
Such a scheme is usually funded by a levy on all other providers.

Question 27

Expectations of a policyholder at discontinuance

Answer 27

The benefits that would have been paid had the contract not discontinued.

Question 28

The interpretation of expectations will involve deciding whether to include: (3)

Answer 28

• future accrual of benefits
• future growth that would apply had the policy/scheme not terminated
• any discretionary benefits (eg discretionary pension increases or enhanced early retirement schemes)

Question 29

3 Common Recovery plan actions

Answer 29

• changing the investment strategy to invest in less volatile asset classes
• increasing the amount of reinsurance the company has in place
• limiting the levels of new business sold

Question 30

If a scheme is in deficit, then either (2)

Answer 30

• some (or all) of the members will have to accept a reduced benefit
• the sponsor will (if possible) be required to make up the deficit.

Question 31

Why might an individual member choose to withdraw from an employer-sponsored benefit scheme prior to retirement?

Answer 31

• The individual might cease employment with the company.
• The company might offer a different benefit scheme.

The individual might want to transfer the benefits to a new scheme:

• for SIMPLICITY (combine pension funds)
• because the new scheme offers GREATER FLEXIBILITY (maybe the circumstances of the beneficiary changed e.g. marriage, dependents. Hence greater flexibility of benefits needed)
• the member is CONCERNED about the FINANCIAL SECURITY of the original scheme
• the member believes that the new scheme offers BETTER TERMS

Question 32

6 Costs of determining and implementing discontinuance terms

Answer 32

Pricing and admin costs

• determining a CALCULATION BASIS
• employing and training STAFF to deal with discontinuance quotations and queries
• COMPUTER SYSTEM development and maintenance costs
• MARKETING LITERATURE

Monitoring costs

• cost of REVIEWING the discontinuance TERMS
• losses incurred due to providing overly generous discontinuance terms / due to ERRORS

Question 33

How would CHANGING THE INVESTMENT STRATEGY to investing in less volatile assets help a faltering company recover?

Answer 33

… reduces the probability of assets being insufficient to meet the liabilities in future.
… may reduce the provisions the company needs to hold (eg the size of any mismatching provision).
… improving the solvency position

Question 34

How would INCREASING THE AMOUNT OF REINSURANCE help a faltering company recover?

Answer 34

should reduce the level of risk faced by the company (by reducing claim volatility).

The required solvency capital may also be lower.

Question 35

How would LIMITING NEW BUSINESS help a faltering company recover?

Answer 35

Selling new business creates capital strain.

Limiting the new business sold limits the amount of capital required to meet new business strain and increases the amount of capital available to demonstrate solvency.

Don’t need to pay marketing etc. save costs

Question 36

Why might limiting the levels of new business sold not make a significant difference in practice for a low-solvency company?

Answer 36

Financial advisers, the financial press and possibly the regulator may warn prospective customers of the risks associated with the company.

Question 37

What might deter an insurer from making the necessary cuts to benefits?

Answer 37

The insurer may be reluctant to make cuts for competitive reasons or for fear of disappointing policyholders’ reasonable expectations.

The insurer might decide to defer the benefit cuts in the hope that the solvency problems are only temporary.