CHP 34 Flashcards
General principles underlying the determination of discontinuance terms for benefit schemes
The key principle is fairness between different parties involved.
The principles underlying the determination of the benefits payable on discontinuance or transfer of rights should be fair to:
• The policyholder or scheme member
• Other policyholders and scheme members
• Provider of the benefits.
1.2. Determining the contracts for which to offer discontinuance terms
An insurance company needs to decide the contracts for which it will offer discontinuance terms. This may be governed by:
• Market practice
• Regulatory requirements
• The difficulty of assessing suitable terms – e.g. lump sum to pay on discontinuance of immediate annuity
1.3. The form of the dsicontinuance benefits offered
The discontinuance terms could take the form of a lump sum payment or converting the contract to paid up.
For some contracts, the discontinuance terms could be guaranteed.
1.4. Setting the discontinuance benefit
The key principle and factor to consider in determining discontinuance terms for life insurance contracts are:
• Asset share
• Policyholder expectation
Policyholder expectation – at short duration: initially policyholders will compare discontinuance with premiums paid, at this stage, this will not be what the company can offer. The company may decide to take a loss on early surrenders and recoup some of this from later surrenders.
Policyholder expectation – close to maturity: here the policyholder will compare to maturity benefits.
• Competitive considerations
Policyholder expectation discontinuance – at short duration:
initially policyholders will compare discontinuance with premiums paid, at this stage, this will not be what the company can offer. The company may decide to take a loss on early surrenders and recoup some of this from later surrenders.
Policyholder expectation discontinuance – close to maturity:
here the policyholder will compare to maturity benefits.
New business disclosures discontinuance
Disclosure at new business stage could be regulated and must contain certain information. This could contain information on discontinuance. This could influence the extent that policies terminating later on subsidise the benefits offered on short duration discontinuance.
Cost of implementation discontinuance
Consider the cost involved in determining and implementing the terms, compared to the benefit available on discontinuance.
1.5. Practical considerations discontinuance
New business disclosures
Ease of calculation
Cost of implementation
Frequency of change of discontinuance terms
2.3. Setting the discontinuance benefits
For benefit schemes the benefits on discontinuance are likely to be known, but if they are to be transferred to another provider a value will need to be placed on them. This value will need to be equitable between the members who stay and those who withdraw.
2.4. Other considerations discontinuance
Schemes may not be fully funded. The assets available to provide the benefits may be only those that are funded, they may be insufficient to provide the full value of benefits to all members. In such cases, the benefit paid to members leaving may be lower to reflect the lower level of funding. In such cases the member may have the option not to transfer away but retain the full discontinuance benefit in the scheme.
- Insolvency and closure – insurance companies
3. 1. Regulation
Because insurance companies are usually subject to regulations, they are usually required to keep solvency capital.
There are also regular reporting requirements that enable the regulator to monitor the financial position. These are designed to enable the regulator to intervene if need be.
- Insolvency and closure – insurance companies
3. 2. Intervention
Because of intervention, insurers rarely become insolvent. If the insurer breaches the required level of solvency capital, the regulator intervenes to protect the interests of existing and new clients.
If the situation is serious, the regulator will close the company to new business so that policyholders don’t enter a fund whose solvency is in doubt.
In most cases, the company will be required to establish a recovery plan and will be monitored closely by the regulator.
Stopping new business, the provider will still have existing liabilities but will have more capital freed up that would have been tied up financing new business strain. This plus the cost saving of not writing new business will enable the insurer to meet liabilities in the short run.
In the long run, diseconomies of scale will bite and further actions will be needed. The insurer may be sold or merged with another insurer who will take on its liabilities.
- Insolvency and closure – insurance companies
3. 3. Projecting solvency
In any of these scenarios, it is important to project the insurer’s solvency position into the future on a range of deterministic scenarios or with the aid of a stochastic model.
It is important to estimate the actions that might need to be taken in various scenarios, include these in the model.
- Insolvency and closure – insurance companies
3. 4. Compensation schemes
When the insurer cannot meet its liabilities (as opposed to not having enough solvency capital) and a buyer cannot be found to take them on, there may be a statutory scheme set up form which some or all of the benefit payments are paid.
Such a scheme is usually funded by a levy on all other providers.
- Insolvency and closure – insurance companies
3.3. Projecting solvency
The issues that need to be addressed and modeled include:
- Estimation of future profits available to equity shareholders, net of tax
- Current value of all surplus assets
- Amount and timing of any loan or debt redemption
- Problems of staff relationships (and redundancies)
- Considerations relating to staff benefit schemes – particularly if schemes are in deficit
- Outstanding financial obligations, minority interests, tax
- Insolvency and closure – insurance companies
3.3. Projecting solvency
If there is an acquiring company prepared to take over the business, it will be necessary to consider:
- Location of the operation
- Any integration of systems and platforms
- Relocation of staff or whether there is an adequate labour force available
- Effect on unit costs
- Insolvency and closure – sponsored benefit schemes
4. 1. Level of benefits
If a benefit scheme is set up to provide benefits for a group of individuals, consideration needs to be given to the benefits that would be payable were the scheme to cease.
This may be because of insolvency of the sponsor or a decision to stop financing the scheme. For State sponsored provision the latter is more likely to be the reason.
The benefits that will be paid to the members of the discontinued scheme will be affected by the following factors:
• Rights of the beneficiaries – this will depend on the terms under which the scheme operates and any overriding legislation.
• Expectations of the beneficiaries – which will likely be the benefits if the scheme did not discontinue.
If there are insufficient assets to meet the rights and expectations of beneficiaries then a lower benefit will be paid.
- Insolvency and closure – sponsored benefit schemes
4.1. Level of benefits
Level of assets – schemes in deficit
Where the scheme is discontinued and it is in deficit, all benefits will be reduced before paying out.
If the benefits are to be reduced, legislation or scheme rules may indicate which types of benefits are to be reduced or which types of beneficiaries are to have their benefits reduces.
The assets for this may be those that have been funded, alternatively there may be additional assets available to secure the discontinuance benefits.
Legislation or ethics may lead to extra funds being made available by a non-insolvent sponsor.
Legislation may require a debt to be placed on an insolvent sponsor, which may rank above, equal or below other debtors.
Insurance may have been taken out that ensures that assets are sufficient in the event of insolvency.
- Insolvency and closure – sponsored benefit schemes
4.1. Level of benefits
Level of assets – schemes in surplus
Where a scheme discontinues with more assets required to cover liabilities, the excess assets may pass back to the sponsor.
Alternatively, legislation or scheme rules may require this to pass to the members in the form of benefit increases.
Either way, it is usual for all members to be granted their basic rights before any are granted additional benefits.
Allocation of any surplus to individuals may also be done taking account of length of membership or other indicators of the extent to which they contributed to the surplus.
- Insolvency and closure – sponsored benefit schemes
4.2. Provision of benefits
If a benefit scheme is discontinued, the following options may exist for the provision of the outstanding benefit payments:
- Continuation of the scheme without any further accrual of benefits
- Transfer of the liabilities to another scheme with the same sponsor
- Transfer of funds to the beneficiary to extinguish the liability. Legislation may not allow an individual to receive the capital value of their benefits. An alternative may exist where the member can place the funds with a suitable insurance company or new employer.
- Transfer of funds to an insurance company to invest and provide a benefit.
- Insolvency and closure – sponsored benefit schemes
4. 2. Provision of benefits
Where the benefits are taken over by a third party (e.g. another insurance company), the benefits may end up being higher or lower than the original level. This will depend on the assumptions used to capitalize and the experience of the new company.
An alternative will be to transfer to a provider who will guarantee to pay a specified level of benefits. The provider will then accept the risk of future experience.
There will be risks for the provider guaranteeing the benefit, and for this they will charge a premium.
As a result the balance of the funds may not be sufficient to provide the benefits that could have been targeted using one of the other forms of provision described.
What is OFFER?
Risk Mitigation Options OFFER Overall impact on distribution of NPV's Feasibility/cost Further mitigation required if secondary risks Effect on frequency/severity/correlation Resulting secondary risks
What is REG CUSHION?
Reasons to keep capital
Regulatory requirement for solvency Expenses of NB/new ops Guarantees and options Cashflow timing Unexpected events e.g. fines, actual experience Smooth profit and balance sheet Help demonstrate financial strength to attract NB and to SandP Investment freedom for some mismatching Objectives and opportunity exploitation NB strain financing
What is SAFER
Reasons to underwrite?
SAFER
Substandard lives are identified and terms changed
Avoid anti-selection
Financial underwriting against overinsurance
Experience in line with expected
Risk classification to set a correct premium for the risk
Reinsurance easier to obtain
What is divergence?
Reasons to analyse surplus
DIVERGENCE
Divergence of A vs Expected, find the effect of
Infomration to management and accounts
Variance looking
Experience momitoring into ACC
Reconcile values for successive years
Group intone off and recurring sources of surplus
Executive remunerations schemes gives data for it
NB strain effects
Check our assumptions are ok
Extra check on valuation data and process
DDM Model Assumptions
D, an annual dividend first paid at time 1
i, constant effective annual required rate of return
g, constant effective annual rate of divdiend growth
i>g
i, g both real or both nominal
taxes and expenses ignored
Dividends are reinvested at rate i
Share held in perpetuity
Factors affecting asset demand
Preferences
Income
Alternatives
Risk/Return
Immunisation problems
Fixed liabilities Small profits Flat yield curve Constant rebalancing Taxes/dealing costs ignored Suitable assets may not exist If timings of cashflows are unknown we can't do it
Problems with past data?
Balance of homogeneous groups changed Experience changes Abnormal fluctuations Changes in how data was recorded Heterogeneity in group we're applying assumptions to Errors in the data Statistically random fluctuations
