Chapter 6: Life Insurance Products

Question 1

Key features of life insurance contracts

Answer 1

• Often long term
• Typically only one claim
• The claim amount (or SA) may be known with certainty
• They are used for protection against death or ill-health, and for savings
• They may be sold to individuals or on a group basis, eg to an employer to cover several employees

Question 2

Assumptions needed to project forward profits in each future year for a life insurer

Answer 2

• Premium rates per policy
• Sales volumes and mix of business
• Investment returns
• Expense levels
• Expense inflation
• Commission rates
• Mortality rates
• Morbidity rates
• Withdrawal rates
• Separate assumptions to calculate provisions (which may be more prudent than those used above)
• Solvency capital requirements
• Tax returns
• Reinsurance premium rates and recovery rates

Question 3

New business strain

Answer 3

Usually, in the first month of a life insurance contract, the insurer receives a premium but also has to pay out commission, initial administration, and underwriting expenses, set up provisions, and any solvency capital. If the outgo is more than the income, this is called new business strain

Question 4

Key risks under life insurance

Answer 4

• Mortality, morbidity and longevity
• Investment risk
• Expenses, not met by premium loadings or charges
• Early withdrawals, before the initial expenses have ben recovered
• New business volumes being too high or too low
• Credit risk
• Operational risks

Question 5

Give examples of customer needs met by a group version of a term assurance product

Answer 5

1. An employer could take out a group TA contract on its employees to provide a death in service benefit, which pays out if an employee dies.
2. A credit card company can take out a group TA contract on its credit card holders to pay off any balance outstanding on the death of the cardholder
3. A supplier of goods with payments in installments could take out a group TA on its payees to cover the difference between the amount owing and the value of the recovered goods upon the death of the payee

Question 6

Under what circumstances are benefits paid under:

1. A critical illness contract
2. An income protection contract
3. A long-term care contract

Answer 6

1. Critical illness - On diagnosis of a critical illness as set out in the policy documentation
2. Income protection - During periods of incapacity due to accident or illness
3. Long term care - When the insured needs home or nursing home care

Question 7

List the 4 main investment types for life insurance contracts

Answer 7

1. Without profit
2. With-profit
3. Unit linked
4. Index-linked

Question 8

Without profit (non-participating) contracts

Answer 8

Benefits or how they are calculated are fixed at outset.

The insurer bears the risk of experience not being as expected but also receives the profits.

Typically used for protection products but also for savings.

Question 9

With profit (participating) contracts

Answer 9

Profits and risks are shared between the policyholder and the insurer. The policyholder is entitled to receive part of the surplus of the company or a sub-fund within the company)

There are both guaranteed and discretionary benefits.

Typically used for savings products buy also used for protection.

Question 10

Unit linked

Answer 10

Benefits depend on the performance of the underlying assets.

Experience risks are generally borne by the policyholder, unless three is a minimum guaranteed benefit.

Used for both savings and protection products, but normally only contracts where there is a significant investment element.

See more page 30 NB

Question 11

Index linked

Answer 11

Gives a benefit that is linked to the performance of an economic or investment index.

Premiums may move in line with the same index, or may be fixed in monetary terms.

Question 12

Pure endowment/ Endowment assurance

Answer 12

• Pure Endowment provides a benefit on survival to a known date and hence operates as a savings vehicle, providing a lump sum on retirement or as a means of repaying a loan
• Endowment assurance also provides significant benefit on the death of the life insured, operates as a vehicle for providing protection for dependants
• A group endowment insurance would enable, for example, an employer to provide benefits at retirement, and maybe also on death in service, in respect of his/her employees

Question 13

Whole life assurance

Answer 13

Provides a benefit on the death of the life insured whenever that might occur.

There would not seem to be a consumer need for a group version of this contract

Question 14

Term assurance

Answer 14

Provides a benefit on the death of the life assured provided it occurs within the term selected at outset.

The cost is usually cheaper than since a benefit payout is not guaranteed

Normally don’t have any benefit paid on withdrawal.

A decreasing term assurance contract can be used to repay the outstanding balance on a loan

A group version would normally be used by an employer to provide benefits to dependants on the death of an employee while in employment

Question 15

Convertible/renewable term assurance

Answer 15

Combine a term assurance with the certainty of being able either to convert to a permanent form of contract (ie an endowment or whole life assurance) or to renew the original contract for a further period, all without further evidence of health being provided.

A comparable group arrangement would be the option for an individual in a scheme covered by a group life policy to convert to some form of individual arrangement on leaving the scheme

Question 16

Immediate annuity

Answer 16

Involves a single premium purchasing an income stream, which commences immediately after purchase.

Impaired life annuities pay higher annuities to those in poor health

A group version may be used by an employer to fund for pensions for his/her employees at or after retirement

Question 17

Deferred annuity

Answer 17

Can be used when there is the time between the date of purchase and the date when the income is required to start.

The contract can be paid for either by a single premium or by regular premiums during the deferred period.

The contract enables individuals to build up a pension that becomes payable on retirement. At the vesting date an alternative lump sum can be offered in lieu of all or part of the pension

The group version can be used by an employer to fund for pensions for his/her employees

Question 18

Income drawdown (Living annuity I think)

Answer 18

Allows an individual to leave their accumulated fund invested and draw an income from it annually. This may be just the income earned on the fund or may also include some of the fund capital

May be limits on how much can be drawn each year and an age limit at which point an annuity must be purchased.

One of the main drivers behind the income drawdown approach is that, should the member die before having to secure an annuity, the member’s heirs can inherit the balance of the fund

Question 19

Investment bonds

Answer 19

These are single premium contracts, normally whole life, designed to enable policyholders to invest for the medium to long term

They are typically written on a unit-linked or investment-linked basis

Question 20

Income protection

Answer 20

Enables individuals to provide an income for themselves and their dependents during the period of long-term sickness or incapacity due to accident or illness.

The policy literature must define what constitutes sufficient incapacity to claim

Typically terminate at retirement age, and do not provide benefits for the first period of the claim. In the first period of a claim, it is assumed that the insured will have other resources, for example, a company sick pay scheme or state benefit provision

The group version can be used by an employer to provide a sick pay scheme for employees

Question 21

Critical illness insurance

Answer 21

Provides a cash sum on the diagnosis of a “critical” illness as defined by the policy documents.

In some jurisdictions, the definition of illnesses may be standardised across all contracts of that type

A group version of the stand-alone contract could be used by an employer to provide financial security for employees in event of contracting a critical illness

Question 22

Key person cover

Answer 22

A life and/or critical illness policy taken out to cover the life of a key person within a business

The benefit may be based on loss of profits to the business, or related to the salary of the key person (to facilitate recruitment of a successor)

Unlikely to be purchased on a group version as it is purchased by a company for its own benefit covering particular employees

Question 23

Long-term care

Answer 23

The contract can be used to help provide financial security against the risk of needing either home or nursing home care as an elderly person, ie post-retirement.

The contract could pay for all the costs of care throughout the remainder of life (an indemnity contract), or could provide a cash lump sum, or an annuity, to contribute towards the cost of care.

A group version of the contract would enable an employer to provide long-term care cover to employees and their spouses and parents