Chapter 34: Discontinuance Flashcards
Overriding principle in determining discontinuance terms is that they are fair to: (3)
- the policyholder or scheme member
- other policyholders and scheme members
- the provider of the benefits
2 Factors for the insurer to consider in relation to discontinuance are:
- 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)
In setting discontinuance benefits, a life insurer must take account of (7)
- the asset share of a policy
- policyholders’ reasonable expectations
- competitive considerations
- new business disclosure
- the ease of calculation of the discontinuance benefits
- the cost of implementing the discontinuance terms
- frequency of change of discontinuance terms
2 Reasons insurance companies rarely become insolvent
- 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
If the insurer’s financial position is serious, then the regulator may require the company to (2)
- close to new business,
- or establish a recovery plan
Issues that need to be addressed and modelled w.r.t. future solvency position:
- 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
- problems of staff relationships (and redundancies)
- considerations relating to staff benefit schemes - particularly if schemes are in deficit
- outstanding financial obligations, minority interests, tax
If there is an acquiring company prepared to take over the business, it is necessary to consider (4)
- 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
A benefit scheme may cease due to (2)
- the insolvency of the sponsor
- a decision by the sponsor to stop financing benefit provision
If a scheme ceases, the level of benefits that will be paid will be affected by (3)
- the rights of the beneficiaries
- the expectations of the beneficiaries
- the level of assets
Procedures if - at time of discontinuance - the scheme is under-funded
Consideration will need to be given to the priority of the different groups of members of the scheme in receiving benefits.
This may be dictated by legislation or scheme rules.
An allowance should be made for the expenses involved in determining the benefit allocations.
Procedures if - at time of discontinuance - the scheme is over-funded
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.
If a benefit scheme is being discontinued, the following options may exist for the provision of the outstanding benefit payments (5)
- 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.
4 possible definitions of “discontinuance”
- 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
In a life insurance contract, discontinuance may mean (3)
- surrender
- lapse
- paid-up
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 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
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.
Discontinuance in the context of a benefit scheme
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.
Deferred status
Member has past benefit entitlement but accrues no further benefits.
Winding-up
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.
4 Things a life insurer should consider in setting discontinuance terms
- 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
The contracts on which the insurance company will offer discontinuance terms will be governed by (3)
- market practice
- regulatory requirements
- the difficulty of assessing suitable terms, eg the lump sum to pay on the discontinuance of an immediate annuity.
3 Main components of the asset share
Accumulation of premiums with investment returns - expenses - cost of cover
(It’s a retrospective reserve)
Cost of cover
The contribution the policy needs to make towards the claims arising on the portfolio of similar policies.
Compensation schemes
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.
Expectations of a policyholder at discontinuance
The benefits that would have been paid had the scheme not discontinued.
The interpretation of expectations will involve deciding whether to include: (3)
- future accrual of benefits
- future growth that would apply other than on leaving
- any discretionary benefits (eg discretionary pension increases or enhanced early retirement schemes)
3 Common Recovery plan actions
- 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
If a scheme is in deficit, then either (2)
- 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.
Why might an individual member choose to withdraw from an employer-sponsored benefit scheme prior to retirement?
- 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
- the member is CONCERNED about the FINANCIAL SECURITY of the original scheme
- the member believes that the new scheme offers BETTER TERMS
6 Costs of determining and implementing discontinuance terms
cost of
- determining a CALCULATION BASIS
- COMPUTER SYSTEM development and maintenance costs
- employing and training STAFF to deal with discontinuance quotations and queries
- MARKETING LITERATURE
- losses incurred due to providing overly generous discontinuance terms / due to ERRORS
- cost of REVIEWING the discontinuance TERMS
How would CHANGING THE INVESTMENT STRATEGY to investing in less volatile assets help a faltering company recover?
… 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
How would INCREASING THE AMOUNT OF REINSURANCE help a faltering company recover?
should reduce the level of risk faced by the company (by reducing claim volatility).
The required solvency capital may also be lower.
How would LIMITING NEW BUSINESS help a faltering company recover?
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.
Why might limiting the levels of new business sold not make a significant difference in practice for a low-solvency company?
Financial advisers, the financial press and possibly the regulator may warn prospective customers of the risks associated with the company.
What might deter an insurer from making the necessary cuts to benefits?
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.
