Chapter 4 Life insurance products (4) - Unit Linked Flashcards
Describe 4 bases on which life insurance products can be written
- Conventional without profits
guaranteed benefits, usually level regular premiums - With-profits
conventional/accumulating
policyholder shares in part/all of future surplus (from within contracts, or other contracts) - Unit-linked
benefits linked directly to performance of specified fund, characterised by fewer gaurantees on benefits/premiums
greater flexibility
can be used for savings and protection - Index-linked
benefits guaranteed to move in line with performance of specified investment index/econimic index
Outline the key features of unit-linked contracts
- Policyholders’s premiums paid into investment fund, buys units
- Value of unit fund depends on value of assets underlying investment fund, equal to units x UP
- Used for savings and protection
- Initial expenses
can be catered for by low allocation rate at start
moderately reduced allocation rate
capital units (attract higher charge) vs accumulation units - Insurer deducts charges from policyholder’s unit fund
from premium before invested
allocation rate, bid-offer spread, fixed amt per premium
from unit funds
fund management charge, fixed regular fund charge, regular charges taken to cover death benfts excess of FV - Maturity value usually equal value of units
- Death benefit may exceed FV of unit fund.
- Surrender value is FV of unit fund, possibly with surrender penalty.
Capital Requirement for Unit Linked
As far as regular premium contracts are concerned, a design that involves a low allocation of premiums to units at the start of the contract is particularly capital efficient. This is because the early premiums can be used to provide a
positive cashflow to the life insurance company, rather than building up the unit fund. This means that initial capital strain is quickly repaid.
Compare conventional without-profits, with-profits and unit-linked products form the consumer’s point of view in terms of cost, flexibility and guarantees
- Conventional without-profits
high guarantees imply higher cost
usually least flexible (to alter premiums/benefits) - With-profits
typically lies somewhere between other two in terms of cost, guarantees and flexibility - Unit-linked
higher/lower expected benefit/premium for given premium/benefit
flexibility in types of levels of cover included, ability to vary premiums according to need
State 3 main charging structures used to meet initial expenses for unit-linked policies
Very low, or zero, initial allocation rate
Reduced allocation rate for significant part of term policy
Higher regular fund management charge
Type of charges under Unit Linked
reduced allocation rate
bid-offer spread
administration fee / policy charge / policy fee (could be fixed or could escalate each year;
could be taken from the premium or from the unit fund)
fund management charge
switch charge
mortality charge
charges for other benefits
Describe risks faced by an insurer which sells unit-linked contracts (9)
- Less guarantees => likely lower risk than non-linked contracts
- Nature/extent of risks influenced by
nature/level of any guarantees,
any marketing/legislative contraints on charges - Anti-selection risk as for comparable non-linked products
- Selective withdrawal risk may be higher due to transparency of fees
- Withdrawal/persistency risk depends on
asset share compared to withdrawal benefit
which may not be guaranteed in amount, but its method of calculation - Investment risk influence by non-unit related guarantees
- Expense risk
less if charges are reveiwable, legislative restrictions on this - Mortality risk depends on
gaurantees given,
competition: selective withdrawals leaving worse lives - Significant marketing risk (due to low level of guarantees)
Describe index linked contracts
- Benefits are guaranteed to move in line with economic performance of investment/economic index in specified contract
- Single or regular premiums
- Surrender value, if applicable, would normally be value of benefits calculated according to index value at time of surrender
- Main risk to insurer, peculiar to these contracts, relates to investment, i.e.
being unable to invest in a way to precisely match the benefit guarantee (i.e. assets held don’t move in line with economic/investment index)
Describe risks of conventional without-profits contrats from the policyholders’ point of view (5)
- Insuffient benefit…
..made worse by inflation over time - Insurer insolvency, unable to fully meet guaranteed benefits.
- Inflexibility of product to keep pace with
- changing disposable income of policyholder
changing amounts of benefit needed throughout financial life - Unaffordability of premiums
accident
sickness
redundancy
other loss of income
Describe risks of with-profits contracts from the policyholders’ point of view (4)
- Insufficient cover
policyholder reduces guaranteed cover, expecting future bonuses
investment peformance worse than expected=> lower bonuses - Insurer insolvency
less than under conventional business <= future surpluses can be used to maintain solvency before being distributed - Inflexibility
changing disposable income of policyholder
changing amounts of benefit needed throughout financial life - Unaffordability
accident
sickness
redundancy
other loss of income - bad publicity if profit distributed is bad
- The company has some investment risk because of the guaranteed sum assured and any reversionary bonuses granted over the term. To the extent that it can reduce bonuses it passes some of the investment risk back to the policyholder. However, the scope for this may be limited by smoothing of payouts and policyholder expectations.
Describe risks of unit-linked contracts from the policyholders’ point of view (4)
- Investment risk
Long term poor performance (in terms of the average annual return over time)
Value low on benefit payment (short term volatility) - Insufficient cover
Guaranteed death benefit likely to be in monetary terms
Influenced by inflation - Insurer insolvency
- Additional underwriting to increase guarantee
Describe risks of index-linked contracts from the policyholders’ point of view
- Investment risk
similar to unit linked (long term poor returns; short term volatility)
except that they depend on performance of index rather than that of a specifically designated asset - Insurer insolvency
greater risk as insurer takes on investment risk (not policyholder)
less scope for reviewing charges for existing index-linked products, potentially increases insolvency risk - Inflexible
prems not keeping up with changes in disposable income
benefits not keeping up with changes in life cycle
Company switching strategy from selling TRAD to IL
It may reduce the level of capital that the insurer needs to hold for the business [½]
Due to lower guarantee costs / passing more investment risk to the policyholder [½]
and the removal of the need to hold capital for smoothing [½]
providing that the insurer designs the product appropriately. [½]
The company will need to change investment strategy [½]
or may outsource investment management. [½]
If the product is set up with variable charges, then it may be possible for the insurer
to increase charges to cover increasing expenses…. [½]
