Chapter 6: Life insurance products Flashcards
What are the key features of life insurance contracts?
- They are often long term
- There is typically only one claim
- The claim amount may be known with certainty
- They are used for protection against the financial impact of death or ill health, and for savings
- They may be sold to individuals or on a group basis, e.g. to an employer to cover several employees.
List the 4 main investment types of life insurance contracts
- Without-profit
- With-profit
- Unit-linked
- Index-linked
How are profits calculated for life insurance contracts?
Premiums net of reinsurance premiums paid:
* + Investment income and gains
* - Claims
* - Expenses and commission
* - Increase in provisions
* - Increase in the cost of capital
* - Tax
* = Profit
What is underwriting in terms of life insurance products?
Underwriting is the process used by the life insurer to decide the level of risk posed by a potential policyholder.
As a result of underwriting, the policyholder may be charged a higher than standard premium, given a lower than standard benefit, or even declined insurance.
The most common form of underwriting is medical underwriting, which can be done by asking questions on the insurance application form.
What are the assumptions needed in Life Insurance?
- 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 the provisions (these assumptions may be more prudent than those used above, for example, a valuation interest rate, valuation mortality rates.
- solvency capital requirements
- tax rates
- reinsurance premium rates and recovery rates
Key Life Insurance Contract risks
- mortality, longevity, morbidity
- investment risks
- expenses, not met by premium loading or charges
- early withdrawals, before the initial expenses have been recovered
- new business volumes too high and hence new business strain, or too low and not enough business over which to spread the overheads
- credit risk
- operational risks
List the 15 life insurance products
- Term assurance (level)
- Term assurance (decreasing)
- Term assurance (renewable)
- Term assurance (convertible)
- Endowment assurance
- Pure endowment
- Whole life assurance
- Critical illness
- Long-term care
- Income protection
- Immediate annuities
- Deferred annuities
- Income drawdown
- Investment bond
- Keyperson cover
Pure endowment / Endowment assurance
- A 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 a means of repaying a loan
- An endowment assurance also provides a significant benefit on the death of the life insured before that date and, in this case, operates also as a vehicle for providing protection for dependants.
A group endowment assurance would enable, for example, an employer to provide benefits at retirement, and maybe also on death in service, in respect of their employees.
Whole life assurance
A whole life assurance will provide 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.
Term assurance
A term assurance provides a benefit on the death of the life assured, provided it occurs within the term selected at outset.
As the policy will not pay a benefit in every case, the cost is usually considerably cheaper.
Term assurances do not normally have any benefit paid on early termination.
A decreasing term assurance can be used to:
1. repay the balance outstanding under a repayment loan, and
2. to provide an income for a family with children following the death of the income provider until such time that the latter can fend for themselves.
The group equivalent of the term assurance contract can be used by an employer to provide a benefit to dependants on the death, while in employement, of an employee.
There are also other uses for a group contract, for example, it can also be used by a credit card company to provide a benefit on death equal to the balance outstanding on a credit card.
Convertible / renewable term assurance
A renewable term assurance is a term assurance with the option to renew at the end of the original contract.
The appeal of this option lies in the fact that the renewal can be made without further medical underwriting.
A convertible term assurance allows the policyholder to convert the term assurance into another type of contract, such as a whole life or endowment assurance.
The point(s) at which conversion is allowed will vary depending on the policy conditions.
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.
Immediate annuity
A single premium purchases the income, which commences immediately after purchase.
Impaired annuities are a more recent innovation, where higher annuities are available for those in poor health.
Contracts for a limited period are called temporary annuities.
A group version of the contract can be used by an employer to fund for pensions for employees at or after retirement.
Deferred annuity
Deferred annuities can be used when there is a time between the date of purchase and the date when the income stream is required to start.
The contract can thus be paid for either by a single or regular premium during the deferred period.
The contract enables individuals to build up a pension that becomes payable on retirement from gainful employment.
The group equivalent of a deferred annuity can be used by an employer to fund for pensions for employees.
Income drawdown
Some defined contribution allow for ‘income drawdown’.
Under such an arrangement, instead of buying an annuity the fund remains invested and the member withdraws an amount of the fund each year.
This may be just the income earned on the fund, or may also include some of the fund capital.
Income drawdown is unlikely to be suitable for individuals with small accumulated funds, as the charges by the insurance company to manage the income drawdown product can be significant.
There may also be legislative restrictions on the:
* amount of the fund that can be withdrawn each year.
* age at which drawdown must cease and a pension 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.
The income drawdown product will be sold to individuals as a way of meeting their retirement needs.
Set out other advantages to the member of the icnome drawdown approach compared to instead purchasing an annuity at retirement
- The member may be able to earn a return on their invested funds in excess of that underlying annuity rates
- The member has flexibility within the legislative requirements in terms of how much to take each year as an income
- Annuity rates may currently be poor but improve in the future.
Describe the risks that the income drawdown carries for the member
- If only the income earned on the fund is taken each year, the member’s income could be volatile
- If too high a level of income is taken, the capital could potentially reduce to zero before the member dies, leaving the member dependent on the state at the end of their life
- The charges taken in relation to administering the arrangement may be high
- The remaining fund on the member’s death may be insufficient to provide adequate benefits for a dependant
- There may be a tax charge on the residual fund on the member’s death.
Investment bonds
These are single premium contracts, normally whole life, designed to enable policyholders to invest for the medium to long term.
A policyholder can usually make withdrawals from an investment bond, however, these may incur a penalty in the first few years of the bond. There may also be restrictions on the frequency with which withdrawals can be made later in the term.
They are typically written on a unit-linked or investment-linked basis.
Investment bonds are purchased by individuals.
Income protection insurance
The contract enables individuals to provide an income for themselves and their dependants in the event of the insured risk occurring.
The most common insured risk is long-term sickness or incapacity due to accident or illness.
These contracts typically terminate at retirement age, and do not provide benefits for the first period of any claim.
In the first period of the claim, it is assumed that the insured will have other resources, such as a company sick pay scheme or state benefit provision.
The group equivalent can be used by an employer to provide a sick pay scheme for employees.
Critical illness insurance
The contract provides a cash sum on diagnosis of a ‘critical’ illness, such as hear attacks, strokes or many forms of cancer, which could be used for nursing and other care.
It therefore meets an important need for financial security in the event of contracting such illnesses.
The benefit may be offered in a ‘stand-alone’ form, where the contract only covers critical illness. In other words, no benefit is paid on death.
Alternatively, it can be offered as a ‘rider’ benefit on another contract.
A group version of the stand-along contract could be used by an employer to provide financial security for employees in the event of contracting a critical illness.
Key person cover
A life and / or critical illness policy taken out to cover the life of a key person within a business.
The benefit payable may be based on loss of profits to the business, or related to the salary of the key person
Key person insurance is purchased by a company for its own benefit, covering particular employees.
It is unlikely to be purchased as a ‘group’ version covering many employees.
Long-term care insurance
The contract can be used to help provide financial security against the risk of needing either hom or nursing-home care as an elderly person, i.e. post-retirement.
The contract could pay for all the costs of care throughout the remainder of life, or could provide a cash lump sum, or an annuity, to contribute towards the costs of care.
A claim is payable on this contract when the policyholder is deemed to have reached aspecified level of disability.
The different levels of care will differ between one contract and another, but typically may include:
* cost of care in own home
* cost of being cared for in a residential home
* cost of being cared for in a residential nursing home
A group version of the contract would enable an employer to provide long-term care cover to employees and their spousess and parents.
Without-profit
A life insurance contract is without profit if the life insurance company has no discretion over the amount of benefit payable, i.e. the policy document will specify at outset either the amount of the benefits under the contract or how they will be calculated
So, the key feature of without-profit business is its guaranteed, non-discretionary nature.
Without-profit contracts tend to be most appropriate when the primary customer need is protection.
With-profit contracts
A life insurance contract is with profit if the policyholder is entitled to receive part of the surplus of the company or of a sub-fund within the company.
The extent of the entitlement is usually at the discretion of the company.
Without-profits contracts do not have this profit participation feature.
Under this contract, the insurer and the policyholder share the profits.
They tend to be most appropriate when the customer need that the contract is addressing is saving.
Savings contracts will tend to have premiums invested in riskier assets than do without-profit contracts, with higher expected returns that are used to form the basis of the discretionary benefit entitlement.
The factors that come into play, when setting levels of bonus include:
* the wish to smooth benefits from year to year, so keeping back some of the profit from the good years, to help in the bad years.
* policyholder expectations
* looking at what competitors are doing
* adhering to regulatory limits on payouts.
Unit-linked contracts
Unit-linked contracts are unitised contracts whose value of units is directly attributable to the underlying value of the invested assets.
Unit-linked contracts operate by paying policyholder premiums into pooled investmetn funds.
Any of the types of contract can be written in a unit-linked form, although normally only contracts with a significant investment element are written in this way.
A unit-linked contract enables consumers either to obtain a higher expected level of benefit for a given premium or to pay a lower expected level of premium for a given level of benefit, than under a comparable non-linked version of the contract.
This occurs because the consumer accepts a significant element of risk, mostly investment risk.
By accepting greater risk, the consumer gains a higher expected return, at the expense of a possibility that the return will be lower than might have been achieved from a non-linked contract.
Index-linked contracts
An index-linked contract enable the consumer to obtain a benefit that is guaranteed to move in line with the performance of an index specified contract.
Normally the index will be an investment or economic one.
Premiums may move in line with the same index, or may be fixed in monetary terms.
Suitable investment indices might be the major domestic equity market indices of any country, or more broadly based international equity indices.
Typical economic indices that might be used include retail or other appropriate price indices.
