Chapter 6 - Life insurance products Flashcards
What are the key features of LI contracts?
Usually long term
Normally only one claim event
Claim amount may be known with certainty
Used for protection against death and ill-health, as well as savings
May be sold to individuals or on a grouped basis, usually through employers
What are the main things which make up the profits/losses of insurance companies? (8)
Net premiums (reinsurance) Investment income
Claims Expenses and commission Net increase in provisions (positive on P/L if decrease) Increase in cost of capital Tax
What is underwriting and how is it used by the life insurer?
Process used to decide the level of risk posed by a potential policyholder.
After underwriting the insurer may decide to charge the policyholder a higher premium, offer a lower benefit, or refuse to insure the individual.
What is new business strain?
How do business recover this NBS?
When the initial outgo from selling policies is higher than the income earned.
Life insurer will typically require some free assets to cover for the new business strain. The loss is then recouped over time since premiums are greater than the expenses and increase in provisions, and solvency capital released may be greater than the claim itself (due to prudence).
What are the main constraints on the investment strategy of a life insurer?
Regulation
Size of free assets and therefore ability to mismatch
Tax laws
What are the key risks under life insurance contracts?
Mortality, morbidity and longevity Investment risks Expense risk Early withdrawals (before initial expenses have been recouped) New business strain (more than expected) Conversely, too little new business to spread overhead costs Credit risk Operational risk
What is analysis of surplus?
Break down any profits/losses into its components to help understand the underlying causes.
Discuss pure endowments.
Definition of benefit:
- Lump sum benefit on survival
- On a known date
Use to meet customer needs:
- Savings vehicle
- Lump sum on retirement
- Means of repaying a loan
Existence of a group version:
- Could allow employer to provide benefits at retirement
Discuss endowment assurance.
Definition of benefit:
- Lump sum benefit
- Either on survival to specified date, or death before that date
- May be allowed to surrender early and receive (reduced) lump sum
- May offer a paid-up-value: Keep policy in force without paying further premiums for a reduced sum assured.
- Could be without-profit, with profit or unit-linked.
Use to meet customer needs:
- Vehicle for providing protection for dependants
- Transfer of wealth through inheritance
- Repaying capital on a loan
- Vehicle for saving money for retirement
Existence of a group version:
- Employer can provide retirement or death benefit to employees
- Could be sold to affinity groups, e.g. clubs or societies
Discuss Whole Life assurance.
Definition of benefit:
- Lump sum benefit on death of insured
- No fixed term (time of death is unknown)
- May be allowed to withdraw early (payment may be at discretion of insurer)
- May be paid-up policy option
- Can be with-out profit, with profit or unit-linked
Use to meet customer needs:
- Funeral expenses
- Liability to tax
- Provides long-term protection to dependants
Existence of a group version:
- No apparent need
Discuss term assurance.
Definition of benefit:
- Benefit on death
- If death occurs within the term specified at the outset.
- Considerably cheaper than whole life since payment is not guaranteed
- Do not normally offer any benefit on early termination (since benefit is not guaranteed)
Use to meet customer needs:
- Protection against financial loss for dependant’s
- Uses of a decreasing term assurance:
1) Repay balance outstanding on a loan
2) Provide income for family with children following death - May have the option to convert, and/or renew the contract without further underwriting
Existence of group version:
- Provide benefit to employee’s dependants on death
- Could be used by credit card company to recoup unpaid debt on death.
- Any supplier of goods which takes payments in instalments from an individual could use grouped term assurance.
Discuss immediate annuities.
Definition of benefit:
- Regular stream of income
- Purchased with lump sum and payments commence immediately
- Predominantly without profit or index-linked, but with profit and unit-linked are available
- New innovation is impaired-life annuities - those in poor health receive higher payments
Use to meet customer needs:
- Income for remainder of the insured’s life
- Income for a limited period (temporary annuities), e.g. pay school fees.
Existence of a group version:
- Can be used by employer to provide pensions for employees
Discuss deferred annuities.
Definition of benefit:
- There is a period after purchase before annuity payments commence.
- Can be purchased with lump sum or regular premiums.
- May include a cash option - can take part of/entire fund as lump sum instead
- Rate at which policy can be converted into an annuity during deferment phase may be guaranteed or based on market rates
Use to meet customer needs:
- Build up a pension fund that becomes payable on retirement
- Cash option allows policyholder to possibly pay off outstanding loans or purchase different savings product.
Existence of a group version:
- Can be used by employer to provide pensions for employees
Discuss income drawdown.
Definition of benefits:
- Member transfers fund from defined contribution arrangement to income drawdown product.
- Instead of purchasing an annuity, policyholder leaves the funds invested and can withdraw an amount from the fund annually
- This may be just income earned on the fund, or include some of the fund’s capital.
- Normally only for large funds, since management charges are normally significant
- Legislation may restrict how much can be withdrawn each year, and age at which drawdown must stop and annuity must be purchased.
Use to meet customer needs:
- Usually heirs would inherit remainder of the fund on death - wealth transfer
- Several risks the customer takes on:
1) Income could be volatile, if only based on fund returns
2) Capital could be reduced to nothing before death if withdrawal rate is too high or return is too low.
3) Could involve high management and admin charges
4) Remaining fund on death may be insufficient to provide adequate benefits to dependants
5) May be a tax charge on residual fund on death.
Existence of a group version:
- None - sold to individuals
Discuss investment bonds.
Definition of benefits:
- Single premium contracts
- Normally whole life
- Enable medium-long term investment for policyholders
- Can make withdrawals from bond, but may incur a penalty during early stages
- May be restrictions on frequency of withdrawals
- Pay lump sum on death
- May be a minimum guaranteed benefit, or may depend solely on investment returns earned.
- Typically unit-linked or investment-linked
- May have fixed term, so lump sum paid on death before term.
Use to meet customer needs:
- Used in similar way to income drawdown products (Usually heirs would inherit remainder of the fund on death - wealth transfer)
Existence of group version
- None - sold to individuals
