Chapter1 Life Products EA Flashcards
The products typically offered in a life insurance market have evolved over time so as to represent
profitable risks to the insurer whilst providing useful benefits to the consumer.
the basic theme of life insurance.
in return for one or more premiums paid by a consumer, the insurer contracts to pay benefits which are in some way contingent upon human life – payment occurs on death or survival.
The simplest contracts provide
specified guaranteed benefits in return for the payment of specified premiums. Variations on this simple basis are discussed later in this chapter (and also later in the course), of which the most notable are with-profits and unit-linked contracts.
simplest contracts referred to above are known as
non-profit non-linked (or without-profits non-linked) contracts – which are shortened (usually) to non-profit (or without-profits) respectively. On first reading this terminology seems to suggest that these contracts are not profitable – but this is not what it means! The name is simply telling us that the policy is neither with-profits nor unit-linked!
terms and conditions of the contract will specify
both the amount of each premium and for how long the premiums have to be paid. When a contract is paid for by regular premiums (typically of level monthly or annual amounts), the premiums would usually be payable for a fixed number of years or until earlier death.
In practice, contracts may also provide
benefits on surrender, but this is usually a non-contractual payment of non-guaranteed amount.
A surrender is said to occur when
a policyholder fails to pay all of the premiums required under the contract, and receives a lump sum (surrender value) in compensation for the premiums paid to date.
The amount paid (at the date of surrender) would normally
not be specified in the contract. But the method used to calculate the amount paid (at the date of surrender) would normally be disclosed in the policy documentation sent to the policyholders at the inception of the policy. However, contracts that give guaranteed (minimum) surrender values can exist.
The payment of a surrender value is just one example of
what can happen when a policyholder stops paying his or her contractual premiums in this way. Another example is that it is usually possible for the policy to continue, without paying any more premiums, but for a reduced benefit amount. This is called making the policy paid up.
Some policies do not pay any benefits if premiums cease before the contractual time: in these cases the contracts are said to
lapse.
Needs of customers
The type of contractual benefit offered provides a useful way of listing the main products. For each contract type, we first give a description of how the benefits provided may be useful to a consumer.
The basic customer needs met by life insurance contracts are
protection and savings. Many contracts protect people (or their dependants) from the financial consequences of unwelcome events, such as death. Other contracts are essentially investments, allowing the policyholder to build up funds for specific things such as an income in retirement, the repayment of a loan, or just a lump sum to spend as the policyholder wishes. Some contracts provide a mixture of savings and protection.
Risks to the insurer
Secondly an outline is given of the risks associated specifically with each contract. These “micro” risks are one part of the overall risk picture. The “macro” aspects are covered in later chapters.
The risks that are being referred to here are mainly risks to the insurance company, rather than the policyholder, although the risks that policyholders take on when taking out life insurance are also important. An example of a “micro” risk (to the insurance company) would be if more deaths than expected occurred on an assurance contract, leading to the insurance company making less profit than expected on the contract. An example of a “macro” risk would be the company becoming insolvent.
The risks borne by the insurance company in writing insurance business vary considerably depending on the type of contract involved. In Chapters 1 to 4 we shall study how and why this variation occurs for the different products that life insurers sell. As suggested above, a “big picture” view of the risks involved in being a life insurance company will be discussed later in the course.
Capital requirements
Depending on the contract design and the particular supervisory regulations, capital may be recouped quickly or only very slowly. All other things being equal, a company is likely to prefer contract types and designs that recoup the invested capital quickly, so that this capital can be used to fund further profitable business.
Taken to its logical conclusion, this would imply that companies would be selling contracts with very high premiums or charges in the first year of any contract. In practice, though, premiums (or charges) are often level or even gradually rising during the policy term. Suggest why you think this might be the case.
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Because of its importance, therefore, we shall be considering the capital requirements of the different types of contract throughout these first four chapters.
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New business strain: a reminder
A large proportion of the costs associated with the contract may occur at the start of the contract, because of items such as marketing, underwriting (the process of assessing risks) and initially setting the policy up on the company’s computer systems. In many markets it is also common practice to pay a commission to the provider of the business, eg the company’s own salesperson or an independent broker.
This means that the cashflow (ie income less outgo) in the first year will be low or, often, negative. This is the amount of money the company has on day 1 of the policy. (This is also known as the policy’s asset share as at day 1 – more about asset shares later.)
A further issue is that the insurance supervisory authorities may require that money (reserves) be specifically set aside to ensure that the company is able to meet its obligations to policyholders. In some countries the supervisory authorities require that the reserves are calculated on a prudent basis. Capital is then tied up because of this need to set aside reserves larger than those the company really believes are needed to meet payouts to policyholders.
The company may also have to maintain a minimum amount of assets in addition to those backing its assessment of liabilities. Such a “required solvency margin” ties up further capital.
The combination of the initial cash outflow, any prudence in the reserves and the need to establish a required solvency margin means that money has to be found initially in order to write the business.
initial capital strain can be written
C=V+E-P
where C0+ = Capital strain at time 0 +
V0+ = Supervisory reserves and minimum solvency margin at time 0+ E0+ = Expenses and commission incurred by time 0+
P = Premium paid by time 0+. 0+
and time 0+ is the point immediately after the policy has been issued, after the first premium has been paid, and all the initial expenses have been incurred. P0+ would be
the single premium, or the first regular (annual or monthly) premium
because the asset share at time 0+ can be written:
A=P-E 0+ 0+ 0+
then the initial capital strain is also the excess of the supervisory reserve and required solvency capital over the asset share on day 0+.)
The personal financial lifecycle can give an indication of
the needs of customers for various life and health and care products at different times in an individual’s life, eg young adult, mid-life adult etc.
therefore important to understand the life insurance needs of the consumer, and how these may change both over personal lifetimes and over calendar time.
This is, of course, an important part of the general commercial and economic environment for the insurance company. A key point is that consumer needs do not remain static, but change as lifestyles, standard of living, education and technology each change over time. For example, if more people become financially better off over time, then the demand for savings products should rise and that for protection may fall. It may also allow more people to accept more risk in the policies they buy (with the greater potential rewards they provide). This will tend to increase demand for the more risky products and reduce demand for the (more expensive) fully guaranteed products. Changes in technology and a more educated public also allow more flexible and complicated products to be sold. These are all changes that affect demand for products over calendar time.
There are also important changes in personal financial needs that affect demand for different types of products over individual lifetimes. This helps to explain the variety of products that are sold simultaneously in any life insurance marketplace. A typical personal financial life cycle (in a country with a developed economy) may proceed as follows (note that the actual age-bands may differ quite widely between individuals):
Ages 16 – 25
May still be in higher education, first job, may or may not have partner, probably
does not own home or have dependants.
Financial needs: may still have some support from parents; may be saving towards future family needs, such as buying a home; paying off student debts; likes to spend money if possible!
(This period can be very short for those who do not continue into higher education.)
Ages 25 – 35
May have partners and sometimes children, large debts (eg if they have borrowed money to buy a home), moderate income and often high expenditure (cost of raising children) but often not much wealth. Financial needs: loans to meet cost of buying home and/or other high expenditure, worried about what will happen to dependants should earner(s) become sick or die. May start saving, possibly for the benefit of children as they grow older. Far-sighted individuals may perceive the need to start saving for retirement.
Ages 35 – 65
Children become older and ultimately independent. Debts reduce, loans are paid off. Income may increase and could well outstrip expenditure. Periods of redundancy may also occur. Biggest financial need is to save for retirement. May also wish to provide for the cost of future long-term care (to protect against the consequences of long- term sickness or disability), and how best to manage the transfer of wealth to the next generation (on or before death). And what do you do with all that other additional disposable income?
Ages over 65
Move from employment into retirement. Few debts, but much lower income. Should have more accumulated wealth. Main risks are running out of money if become very old, and an increasingly imminent need for long-term care. Still wish to save disposable income for leisure activities and for wealth transfer. As you study the remainder of this and the next six chapters, think about where each of the products you meet fits into the personal financial life cycle. Also think about whether you would expect the products described to be popular in your own country. (We will return to this again at the end of Chapter 4.)
The product cycle and the nature of the product
The risks posed to the insurer and mitigating measures should be considered at the product design stage. The product cycle can be used to identify possible risks for the particular product and feasible techniques to manage these risks.
All areas (pricing, underwriting, claims management, marketing and sales, experience monitoring and valuation) within an organisation make an important contribution to the experience that emerges. We will see later in the course how, for example, the product design, underwriting, claims’ management and pricing of IP, CI and LTCI products are all more complex than they are for, say, life insurance products.
Product design
The product features (eg events covered) are determined as part of product design in the product cycle. The needs of customers that the product aims to meet, risks to the insurer, distribution methods and marketing and designing administration systems and pricing are considered at the product design stage. The design of the product will be adjusted based on results from the pricing and risk identification exercises and input from marketing and sales and administration departments. Factors that should be considered in designing new products are discussed in more detail in Chapter 20.
Pricing
Experience will vary by office, but it is imperative that the practices employed by each area of the product cycle are reflected in the premiums charged (eg weaker claims management should be reflected in higher premium rates).
Administration
Policy and claims files must be maintained by the insurer. Administration systems must be able to cope with the complexity of the product designs. For example for IP and LTCI policies the system must be able to make regular claims payments, and record a lot of information about each claim. An obvious example is that the system should not only be able to record the date a claim starts, but also the reason for the claim, the date it ceased, and why.
Marketing and sales
Marketing and sales strategies may influence the characteristics (and thus the risk) of the lives insured. The insurer will also need to consider the appropriate distribution method and the costs of marketing and selling the product.
Underwriting and claims management
The rigorousness of underwriting and claims management will have a direct bearing on the claims experience of the product. However, onerous underwriting processes may have a negative impact on business volumes and a balance is therefore required. Underwriting and claims management are more complex for IP and LTCI products (and possibly for CI if tiered benefits are available) than for most other life assurance products. Both have fundamental implications for the resulting claims experience.
Experience monitoring and valuation
The impact of reserves including the regulatory requirements for the policyholder liabilities and capital requirements should be considered when designing the product.
Experience monitoring provides the insurer with information that can be used to update the product design, sales and claims processes, as well as assumptions used in the pricing or valuation of the liabilities. Appropriate data needs to be gathered and stored in a way that facilitates analysis of this information for experience monitoring purposes.
The impact of reserves including the regulatory requirements for the policyholder liabilities and capital requirements should be considered when designing the product.
Group products
The first seven chapters focus mainly on individual cover for life and health and care insurance products. Group life and health and care products are also available in most insurance markets.
Group business is defined as any collection of individuals who combine to make a single proposal for uniform insurance cover.
Group covers are different to individual covers in that they cover a number of individuals under a single policy document.
Usually the collected individuals will be employees in the same company and the employer will pay for the premiums either wholly or in part. In most cases, the employer is the policyholder and the employees are the insured.
Group products can arise where:
● the employer pays the whole premium on behalf of the employees
● where the cost is shared between the two parties (the employer may pay part or all of the employee cost but the member must pay for any coverage desired for spouse or children)
● where the employer facilitates with payroll deduction but the employee pays all costs
● where the “group” is not employment based but linked to club membership (affinity groups) or credit cards.
Another key difference is that
while individual business may be long term, group business is written over a short period – typically one or two years. Cover would be provided for claims that occur during the period of cover, eg individuals who become disabled during the period of cover would be eligible to claim under that insurance arrangement. Therefore group policies may be considered to be short-term, regularly renewable products, even if they are written by a life assurance company. The premium paid for each period of cover will depend on the number of (and characteristics of the) individuals covered by the policy.
Contracts that insurers sell
Endowment assurances
Whole life assurances
Term assurances
Convertible or renewable term assurances Immediate annuity contracts
Deferred annuity contracts Unit-linked contracts Index-linked contracts
Although unit-linked and index-linked contracts have separate sections to themselves (in Chapter 4), linking is essentially an approach to product design that can be used with most of the contracts covered in Chapters 1 to 3. Hence they are not strictly products in their own right.
Most of the contracts in Chapters 1 to 3 could
come in linked or non-linked form. We shall therefore use our first contract, the endowment assurance, to illustrate both linked and non-linked designs. For the other contracts we study in Chapters 1 to 3 we shall concentrate largely on the non-linked versions. When we come to study unit-linked contracts specifically, in Chapter 4, we shall use one or two of the contract types to illustrate the key features of unit-linked designs and how they differ from non-linked designs.
Endowment assurances: needs of consumers
An endowment assurance is a contract to pay a benefit on survival to a known date and hence operates as a savings vehicle, for example to provide a lump sum on retirement, or a means of repaying the capital on an interest-only loan. The contract may also provide 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.
