Exams P2 Flashcards
Market option pricing method for pricing guarantees
Consider market prices for options that replicate the guarantee, for example European put options on interest rates, call options on bond prices, or swaption prices (for a swap to receive fixed and pay variable).
Options terms (interest rate, duration) should reflect the annuity guarantees.
If market prices are not available estimates can be provided by market participants.
Stochastic simulation method of pricing guarantees
Using a stochastic model of interest rates project interest rates (bond yields) to those ages where the option could be exercised.
Assess the probability of interest rates falling below the guaranteed rate, and the average difference, and apply to projected fund values to estimate the potential cost.
Calculate a discounted value of the potential cost.
why would an insurer request that 100% of a particular risk is reinsured?
- may consider the price offered to be very good value for money.
- might not have sufficient experience of selling this product.
- may need solvency relief, which could be achieved by passing on all of the risk to the reinsurer.
- may not see this as a core part of their business, and thus be happy for the reinsurer to take on all of this risk and manage the portfolio.
- may have no particular risk appetite for that particular market segment.
- may want to reduce the volatility of its claims experience.
why would a reinsurer agree to reinsure 100% of a particular risk from an insurer
If the reinsurer has priced correctly the quoted price should result in the required level of profit to the reinsurer.
Expenses will probably be spread over a larger premium than initially expected, so it should generate even better profit than originally priced.
The reinsurer may agree to reinsure 100% of the risk to maintain a good relationship with the insurer if the remainder of the insurers reinsurance programme is profitable to the reinsurer.
why would a reinsurer decline reinsuring 100% of a particular risk from an insurer
- insurer has no interest in the experience and management of the portfolio if 100% of the risk is reinsured.
- This could lead to the insurer being less vigilant on underwriting and claims decisions.
- The reinsurer may specify strict underwriting and claims assessment requirements as part of this agreement.
- This is especially true if the reinsurer cannot re-price the business at a later point in time.
- The request to reinsure 100% of the business may lead the reinsurer to re-evaluate its pricing (the reinsurer may have been too aggressive in the pricing initially).
what are the additional risks taken on through reinsurance
Risks taken on:
Counterparty risk / Credit risk – The reinsurer may be unable to pay the claims as they arise.
Legal risk – A reinsurance contract will need to be entered into, and no contract is completely clear and unambiguous.
Systems risk – insurer will need to pay over the reinsurance premium (which have to be calculated) and ensure that the reinsurer is informed of every life covered. This will need to be done electronically and thus systems risks arise.
Operational risk – insurer will remain responsible for the underwriting and claims. Failure to perform these processes as per the reinsurance contract would introduce operational risks.
why would making a policy paid up be attractive to phs
Policyholders’ circumstances could change eg redundancy, making future premiums unaffordable
Policyholders’ needs may change, making contract unsuitable eg if they have repaid their interest-only mortgage and hence policyholders would find the flexibility to make policy PUP attractive.
Policyholders may prefer continuation of contract in PUP form so as to still have life cover, compared to the alternative of surrendering the contract.
list ways in which a unit linked product can be restructured to reduce the capital strain
Reduce the premium allocation rate.
The company could employ actuarial funding or use negative non-unit reserves.
The maximum commission upfront could be reduced .
The company could introduce a bid offer spread charge.
The investment portfolio guarantees could be removed.
Features of the gross premium valuation method:
an explicit allowance is made for expenses
an explicit allowance can be made for vested and expected future bonuses
the future premiums valued are the actual (“office”) premiums expected
any differences between the pricing and valuation bases will immediately be taken as profit or loss
a prudent basis should defer the release of profit over the lifetime of the policy
reserves may initially be negative for non-linked business, partly due to initial expenses and partly due to capitalising the expected future profit
the reserves tend to be quite sensitive to changes in basis
what is the purpose of a minimum solvency margin. what is the relationship between the reserves and the margin
This solvency margin provides an additional level of protection to policyholders (protection against insolvency, protection against systemic risk, to maintain market confidence, to reduce the risk of reserves being insufficient, to act as an early warning system for the supervisor) against future experience being worse than reserved for under the supervisory reserving basis.
The required margins in the reserve calculation and solvency margin calculation should reflect the risk of the insurer.
There is a direct relationship between the level of prudence in the supervisory reserves and a suitable level for the required solvency margin.
The level of prudence in the reserves (i.e. prescribed margins) implies that the minimum solvency margin required as protection for policyholders should be lower.
The distribution channel may impact on the product Expected mortality and withdrawal experience through the following
financial sophistication of the target market
who initiated the sale
extent to which distribution channel explains product features accurately
level of underwriting
demographic characteristics
The distribution channel may impact on the product Expected expense experience through the following:
Sales volumes will be affected by how well the distribution channel does which will impact on expense experience and number of policies that can cover overhead expenses.
Expenses of the different channels to the company may also be different i.e. extent of admin required to get policies on the books.
what are the aims of the government in providing healthcare and welfare.
- to protect the health of the nation
- to subsidise the poor
- to balance the budget
- to follow social and political promises
list the risks associated with the HC policies from the insurer’s perspective
- Anti-selection risk
- Lapse risk
- Expense risk and expense inflation risk
- Data risk
- Claim risk
- Severity risk
- Longevity risk
- Investment risk
- Environment risk
- Volumes of new business
- Competitive risk
- Reputational risk
- Policy wording
- If it is an indemnity benefit
- Demographic changes
- Any guarantees
• Anti-selection risk
– risk of policy being purchased only by those likely to claim
