Chapter 9 The general business environment (2)

Question 1

Outline

main types of expenses an insurer may incur in running business and (6)
what they are influenced by (3)

Answer 1

• Commission
  initial, payable on acquisition of new policy
  renewal, payable on premium renewal
• Management expenses
• • Indirect
    overheads: incurred irrespective of new/in-force business e.g. costs of general management, property
• • Direct:
    incurred directly for new business written/maintain existing business
    fixed: stable in short term, doesn’t change with busines written
    variable: change with volumes of business written
• Expenses influence by
  wage/salary levels
  general levels of prices
  prices of specific commodities

Question 2

State 2 main risks with regard to expenses

Answer 2

• Profitability risk
  loadings insufficient to meet actual expenses incurred
• Risk that company cannot control costs
  poor management
  inflation

Question 3

Explain how legal risks may arise for an insurer (5)

Answer 3

1. PRE
   some principle of acting unfavourably to insurer
   e.g flexibility in bonus method being constrained
   legally required to distribute profits in way that is kept consistent with PR
2. Unfair terms voiding contract
   e.g. if particular charge reviews by fixed rate, say, specified in contract seen as unlawful
   risk of ability to review charges being removed
3. New legislation over time
   that could change legal contract betwen insurer and existing policyholders
4. Misprepresentation
   inconsistency in policy documents and other relevant representations made by company or its agents
5. Insurance contracts spanning several years
   hence open to developing legal cultures, interpretations, court judgements

Question 4

State main advantages and main disadvantages of life insurance company regulation

Answer 4

• Main advantages:
  protection of policyholder interests
  companies don’t always manage affairs properly
  large sums of money over long term
  public need confidence
• Main disadvantages
  Cost to policyholder either directly and/or indirectly e.g. through reduced innovation
  Impacts contract design

Question 5

List 8 regulatory restrictions commonly imposed on life insurance companies

Answer 5

Types of contract that can be offered
Contract terms and conditions e.g. how surrender values are calculated
Ability to underwrite e.g. prohibition on use of generic testing/past claims history
Rating factors that can be used to calcualte premiums
Premium rates/charges
Sales channels/sales procedures or info given during sale
Amount of business that maybe written (indirectly) e.g. due to minimum reserving/solvency capital requirements
Investments e.g. types of assets allowed whether mismatching allowed

Question 6

Briefly describe 2 common ways of taxing life insurance business

Answer 6

• Profits basis
  Tax on annual profits of business, where profits means excess of change in value of assets over change in value of liabilities
  Reserves used will generally be supervisory basis, because limit’s company’s ability to manipulate reserve amt, hence taxable profit
  Focuses on shareholder profit
  profit distributed to WP policyholders automatically excluded from profit calc, since they would increase reserves and reduce assets
• I - E basis
  Tax payable on investment income/gains less some or all of operating expenses of company

Question 7

Describe how taxation system can influence product design and sales for life insurance company

For policyholder (1,2)

For insurer: current implications (3,1)

For insurer: future implications (2)

Answer 7

• For policyholder
  Tax treatment in policyholder’s hands can influence buying habits, and attractiveness of life insurance
  tax treatment of premiums paid
  particulalry when premiums are deductible from individual’s taxable income in part/full/not at all.
  tax treatment of eventual policy benefits
• For insurer: current tax implications
  Product design make use of opportunities offered
  ability to maximise favourable taxation treatment may force constraints on product design
  Tax concessions helps ease sales of certain contract types easier
  Tax treatment impacts life insurance attractiveness
  tax treatment of insurer’s funds
• For insurer: future tax implications
  Taxation risk from changes over time, important to bear in mind when benefits gauranteed over long term
  existing policies not immune from effects of changes
  company risks making less profits that anticipated in pricing