Chapter 9 The general business environment

Question 1

List the factors in the general business environment which affect a life insurer’s business (8)

Another useful acronym from CA1/ARM

(CREATE GREAT LISTS)

Answer 1

DERLF PEP

1. Distribution channels used and their impact
2. Economic environment
3. Regulatory contraints/opportunities
4. Legal environment
5. Fiscal regime
6. Propensity of consumers to purchase products
7. Expenses and commission
8. Professional guidance

Useful CA/ARM list for the external environment within which insurer’s operate

• Competition & the underwriting Cycle
• Regulation
• Environmental & Ethical considerations
• Accounting standards
• Tax
• Economics (interest rates, inflation, economic growth, exchange rates)
• Governance (corporate)
• Risk management (operational, credit, market)
• Experience from overseas
• Adequacy of capital and solvency requirements
• Trends (demographics
• Lifestyle
• International practice
• Social trends
• Technological changes
• State benefits

Question 2

The factors to consider in the general environment

List the various factors in the general business environment which influence the health and care insurance/industry (11)

Answer 2

• Various commission structures
• Propensity to buy health insurance prods vs need to sell health insurance prods
• The regulatory regime
• The fiscal/tax regime
• Professional guidance
• Economic influences: inflation
• Economic influences: other economic influences
  
  • Business cycle
  • Employment security
  • Investment returns
  • Political stability

Question 3

Commission: different structures/types

List the different types of commission structures which may exist on health and care insurance products (5)

What key factor may affect the commission structures often experience in the health and care general business environment? (2)

Answer 3

Commission types

• Initial commission and Renewal commission
  
  • May be on an indemnity basis
• Level commission
• Alternative commission structures

Commission may be affected by

• market norms, and
• regulation

Question 4

Commission: initial commission and renewal commission

What do we mean by initial and renewal commission? (5)

Answer 4

Initial and renewal commission refers to commission structure(s) which:

• pay generally high commission over an intial period (initial commission)…
• ….and a lower level of commission thereafter (renewal commission)
  
  • renewal commission is generally only payable upon policy renewal (ie only on policy anniversay)
  • renewal commission encourages distributors to promote persistency
• varies per product eg PMI will have a higher commission for new business than for renewals

Question 5

Commission: initial commission and renewal commission

What do we mean by indemnity commission? (5)

In what form is indemnity commission paid, and how might is be calculated/expressed? (4)

What is the benefit to the distributor of indemnity commission? (1)

What implication does the use of an indemnity commission structure have for the insurer? (3)

Answer 5

Indemnity commission:

• Initial and renewal commission are usually(?) paid via an ‘indemnity commission’ framework ie on an indemnity basis
• With indemnity commission, the distributor is paid commission (initial or renewal) in respect of premiums that haven’t been received yet i.e. distributor receives payment of commission in respect of service which hasn’t fully been “earned” as yet
• The adviser (distribution channel) usually earns indemnity commission over a defined period called the ‘earnings period’, which is normally stated in months

Form of indemnity commission and calculation

• the indemnity commission takes the form of a lump sum paid by the insurer to distributor for new business written
• may be expressed as a % of
  
  • sum insured or
  • premium

​​

Benefit to distributor?

• Indemnity commission may be paid to any distributor who needs cash up-front to develop his/her business.

Implications of indemnity commission structure for insurer

• would lead to some form new business strain, as upfront lump sum needs to be funded from premiums not yet received
• system incentivises selling new products rather than building up long-term relationships

Question 6

Commission: initial commission, indemnity commission, clawback arrangements

What do we mean by clawback arrangements in the context of indemnity commission? (6)

How is clawback usually calculated? (1)

Answer 6

Clawback arrangements

• These apply in the context of indemnity commission paid
• The adviser earns indemnity commission over a defined period, earnings period, which is normally stated in months.
• A clawback arrangement is a mechanism through which an insurer can recoup (‘claw back’), in full, or in part, for indemnity commission paid to a distribution channel, should the policy with respect to which such commission was paid lapse during the earnings period ie before the commission was deemed to have been fully earned.
• If a policy lapses during the earnings period/before the commission is fully earned then insurer may clawback a proportion of the commission from distributor.
• No clawback applies for lapses which occure after the earnings period

Calculation of clawback

• clawback is usually calculated by a formula in the commission agreement.

Question 7

Commission: level annual commission

What do we mean by level commission? (2)

What are key advantages to the insurer of level commission, compared to, initial indemnity commission? (2)

What is a key drawback of initial commission from the POV of the distributor? (1)

Answer 7

Level commission

• on alternative structure (to initial and renewal commission), where…
• …every premium paid by policyholders entitles the distributor to a proportion of said premium.

Key advantages for insurer

• level commission doesnt involve any new business strain
• better matches commission to premium and profitability

Key drawback for the distributor

• it takes longer for distributor to earn their commission

Question 8

Commission: alternative commission structures

Give 2 examples of alternative commission structures which may be used by insurers (4)

Answer 8

• initial commission may sometimes be spread over a limited number of years
• sometimes commission is paid as a % of sum assured
  
  • this shows preference for high sums at risk rather than premiums
• where high initial commission is used, often lower commission as renewal to encourage persistency
• commission may be affected by market norms and regulation

Question 9

Propensity to buy vs need to sell: what makes a policy sell?

List factors that makes a health insurance policy ‘sell’? (2)

Give reasons why health insurance may be acitvely bought/sought/pursued by potential customers (4)

Give reasons why health insurance is not actively bought/sough, but may need to be sold to potential customers (4)

Where do health insurance products lie on the spectrum in terms of it needing to be sold, vs it being actively sought/pursued? (2)

Answer 9

For health insurance policies to sell, the may either

• be actively bought/sought by customers, or
• need to be sold/pushed by insurers

Reasons why health insurance may actively be bought/sought:

• genuined desire to meet priority need
• perceived contract benefits outweighs the cost + inconvenience
• it might be a legal requirement
• person is persuaded they want the contract

Reasons why health insurance may need to be sold:

• people unaware they have a need for product
• needs are comlpex and the required explanation or advice may be offputting
• incapacity/serious ilnesses are often tabook subjects
• costs of products may be too high

Health insurance being sought/pursued vs it needing to be sold?

• health and care lies between those bought and sold.
• protection plans meet needs, but are in competition with state welfare benefits

Question 10

Propensity to buy vs need to sell: influence of selling characteristics of PMI

Describe the characteristics of PMI which make it more desirable to be actively bought/sought/pursued vs it needing it to be sold (2)

Answer 10

• If all medical expenses are the responsibility of the individual then this becomes a need for the policyholder, and PMI products will be actively bought/sought/pursued
• However if the State provides care then the PMI products will have to be sold rather than actively bought/sought/pursued

Question 11

Propensity to buy vs need to sell: influence of selling characteristics of LTCI

Describe the characteristics of LTCI which make it more desirable to be actively bought/sought/pursued vs it needing it to be sold (2)

Answer 11

• LTCI depends on the perceived attitude of governments to provision of care.
• There may be some elements of legal compulsion in some countries.

Question 12

Propensity to buy vs need to sell: influence of selling characteristics of CI insurance

Describe the characteristics of CI insurance which make it more desirable to be actively bought/sought/pursued vs it needing it to be sold (3)

Answer 12

• CI insurance is not linked to match specific financial need.
• The sum can be used to meet any financial needs (if any).
  
  • This makes it somewhat attractive to be bought/sought/pursued
• It is sometimes sold rather than being sold.

Question 13

Propensity to buy vs need to sell: impacts of future developments in healthcare insurance

Describe how future developments in the healthcare insurance environment are influencing the extent to which health care products are bought/sought/pursued vs needing to be sold by insurers

Consider

Growing awareness of the State’s abilities (5)

Regulation (2)

Impact of mis-selling (2)

Answer 13

• There is growing awareness that the State cannot continue to provide wellfare benefits at the same level, given
  
  • …comittments to low taxation,
  • aging population
  • decreasing taxable workforce…
• …this awareness increases attraction of health and care insurance products
• Increasing sales regulation and disclosure over time has reduced insurer’s ability to ‘create’ needs through sales process
• There is a growing tide of mis-selling, which makes insurers wary of pushing past obvious needs

Question 14

Regulatory regime: aim of regulation

What is the kay aim of regulation? (2)

Answer 14

• The main aim of regulation is to protect the policyholder.
• This would be done via governments which may impose restrictions on the way which insurance companies operate.

Question 15

Regulatory regime: examples of regulatory restrictions

Discuss different types of restrctions that regulators may apply via regulation (15)

Answer 15

Common regulatory restrictions are as follows:

• Restrict type of contracts insurer can offer
  
  • e.g. no indemnity PMI as in SA
• Restrict premium rates or charges on some types of contract
• Restrict terms and conditions
  
  • e.g. paid-up, surrenders, claim definitions
• Restricting channels through which insurance be sold and minimum disclosure requirement
  
  • May require minimum training of salespeople, cooling-off period, illustrating surrenders
• Restricting ability to underwrite
  
  • e.g. no genetic tests
• Indirect constraint on amount of business written i.e. through reserves and solvency margin
  
  • These limit capital available and require a minimum capital to write a contract
  • Will need Free Assets to expand
• Restrictions on type of asset may invest for solvency purposes
• Restrictions on amount of type may invest for solvency purposes
  
  • May also restrict amount of asset or type that can be used in supervisory valuation

Question 16

Regulatory regime: regulation on different institutions

Discuss how the general business environment influences insurers providing healthcarae products, in terms of regulation which applies to different institutions (6)

Answer 16

• Insurers usually have a monopoly on pure protection products, but not on savings products (which can be offered by a wide varierty of organisations).
• Having said that, other organisations eg banks may be allowed to offer arrangements that can be regarded as competing with health and care insurance products
  
  • such organisations might be subject to different regulations compared to insurers, creating an uneven playing field
  • eg the different regulations on banks (Basel Accords) and others

Question 17

Regulatory regime: contract design impact due to regulation

How does regulation affect contract design? (3)

Answer 17

• regulation significantly affects contracts sold
• contract design will have to take regulatory constraints imposed into consideration
• insurers will want to make use of the best available regulatory opportunities available to them

Question 18

Fiscal/tax regime: approaches to taxation

The fiscal/tax regime operating in the general business environment will influence health and care insurer’s who operate in that market.

Describe the various approaches to taxation which may be encountered (3)

Which approach may be used in practice? (1)

Answer 18

Insurers may be taxed in a number of different ways:

• tax on annual profits of business (business view)
  
  • where profits means excess change in assets over change in liabilities
• tax payable on investment income (investors pooling view)
  
  • may be less operating expenses
• tax on premium income

The approach used in practice may be stipulated as that which leads to the higher tax amount

Question 19

Fiscal/tax regime: tax on profits approach

How does this tax regime work? (3)

What reserves are used in the calculation, and why? (3)

Answer 19

How tax regime works

• for this tax regime, the taxable amount is the annual profits earned by the insurer ie tax is applied to the annual profits earned by the insurer
• taxable amount => profit between over year_(t) to year_(t+1) => could be stated as:
  
  • (A_(t+1) - A_(t)) - (V_(t+1) - V_(t)) ie change in assets over change in liabilities
  • (A_(t+1) - V_(t+1)) - (A_(t) - V_(t)) ie increase in free assets over the year

G​enerally reserves are supervisory reserves

• reducing the ability to manipulate profits
• also, this way, allows profit to be distributed as changes in excess of supervisory reserves

Question 20

Fiscal/tax regime: tax on investment income approach

How does this tax regime work? (3)

Answer 20

• For this tax regime, the taxable amount is the “investment income earned by the insurer” over the tax year
• the taxable amount may include some or all of the capital gains realised.
• the taxable amount should allowed for expenses on returns as well.

Question 21

Fiscal/tax regime: impact on different types of insurance business

In what way may the fiscal/tax regime influence insurance business? (8)

Answer 21

• Different types of business may be taxed differently (short term vs. long term, conventional vs. unit-linked)
• It’s possible for policyholders to be paid with gross investment returns and then be taxed
  
  • this may imply that it is cheaper for policyholder to earn form of benefit as a different type
• Tax treatment may also influence buying habits; depends on:
  
  • taxation of premiums (income deductible or not),
  • taxation of insurer’s funds
  • taxation of policy benefits

Question 22

Fiscal/tax regime: impact on contract design

In what way may the fiscal/tax regime influence contract design? (4)

Answer 22

• Insurer will want to make best use of fiscal environment, take advantage of favourable tax treatment.
• the ability/desire to maximise favourable taxation may force constraints on product design:
  
  • eg tax authorities may be keen that pure savings business should not be dressed up to look like healthcare protection insurance in order to secure favourable tax treatment.
  • they may specify minimum level of cover necessary to secure tax concessions.

Question 23

Professional guidance

Who might issue professional guidance (in the context of health care insurers) and in what way may this professional guidance be a factor in the general environment that health insurance providers operate in? (3)

What kind of areas might be covered by professional guidance? (3)

How might actuarial guidance interact with government regulations? (3)

Answer 23

Actuarial associations will often issue professional guidance to actuaries

• these will provide a framework of points they need to consider in carrying out their responsibilities
• the guidance should not restrict actuaries, but rather protect them against industry pressure and allow agreement on best course of action

The guidance may typically cover areas such as:

• policy conditions
• adequacy of premium rates for new business
• value of liabilities

Professional guidance may provide interpretation of government regulations

• this occurs where gov does not want to be overly prescriptive, and…
• …but instead relieas on actuarial profession to interpret regulations adequately

Question 24

Economic influences: intro

What kind of economic influences/factors exist in the general busines environment that healthcare insurers operate in? (5)

Answer 24

Main economic influence:

• Inflation

Other economic influences

• Business cycle
• Employment security
• Investment returns
• Political stability

Question 25

Economic influences: main economic influence, inflation

Describe the influence of inflation on the general business environment that health care insurers operate in.

Consider the needs being met by the health insurance products (1)

Consider the impact of inflation on the needs being met by policies with the following types of benefits

Fixed level benefits (1)

Benefits with a fixed escalation rate (2)

Index-linked benefits (2)

Indemnity based benefits (3)

What other assumptions would inflation impact? (2)

Answer 25

In terms of needs being met by health insurance products

• Policies must meet needs in current and future lifetime of contract
• Inflation plays a big role in achieving this

Fixed level benefits

• even if a contract offers fixed benefits the policyholder should be encouraged to frequently review level of cover and reapply

Benefits increasing at a fixed escalation rate

• policyholder shold accept that this is not inflation protection
• should be encouraged to frequently review benefits and reapply

Benefits increasing with national inflation index

• some benefits may increase in line with CPI however the policyholder should still consider reviewing care and reapplying…
• ….because of the danger that costs of medical care usually/sometimes increases at greater rate than CPI.

Benefits not fixed but indemnify actual healthcare costs

• where a contract indemnifies the actual cost of healthcare the insurer bears the risk of covering inflation
• for one-year contracts, premiums are reviewable annually and can be readjusted
• on longer-term contracts, premiums may not be reviewable, insurer will need to keep level of prospective reserves consistent with both current and future expected cost levels.

Other important assumptions influence by inflation

• Inflationary pressure applies to expenses and policy/claim admin.
• Need suitable reserves for this

Question 26

Economic influences: other economic influences, business cycle

Describe the influence of the business cycle on the general business environment that health care insurers operate in.

Consider

times of economic upturn/bouyency (3)

times of economic downturn (2)

Answer 26

During times of business optimism

• there is a positive demand for employer-sponsored insurance, to attract best employees and/or retain best staff.
• individuals are generally to renew existing policies, or upgrade cover on existing policies

During times of economic downturn

• employers may be under pressure to cut costs, and hence reduce benefits
• individuals may change or cancel their health insurance products bought

Question 27

Economic influences: other economic influences, employment security

Describe the influence of employment security on the general business environment that health care insurers operate in (4)

Answer 27

• for individuals, confidence in continuity of remuneration promotes likelihood of insurance purchase
• for employees covered under employer-sponsored schemes they may claim more when there is lack of confidence in longevity of one’s employment or cover
  
  • eg more likely to claim when they feel the benefits will be withdrawn,
  • incentive to have treatment or check-ups

Question 28

Economic influences: other economic influences, investment returns

Describe the influence of investment returns on the general business environment that health care insurers operate in (1)

Answer 28

• The returns available are an important aspect for insurance companies
  
  • These may influence the profits an insurer may earn, hence its ability to
    
    • generate wealth/returns for its investors/equity providers
    • provide returns to customers
    • grow over time…
    • …hence continue to provide benefits

Question 29

Economic influences: other economic influences, political stability

Describe the influence of political stability on the general business environment that health care insurers operate in (5)

Answer 29

• some political regimes create a more advantageous environment of health and care insurances than others
  
  • eg government’s attitude to PMI as an alternative or complement to State welfare can drastically affect public buying habits
• political stability:
  
  • can indicate national economic wellbeing
  • can mean stability of rules governing the insurance industry
  • is generally desirable by policyholders as it indicates stability of future economic value of their insurance policies