F_Short q's 7

Question 1

(ii) Explain why the term assurance contracts are unlikely to offer any withdrawal benefits [2]

Answer 1

(ii) Reasons why withdrawal benefits are unlikely:
• Term assurances have low reserves, as there are no maturity values and only death benefits need to be reserved for, and so there is little scope to pay worthwhile withdrawal benefits.
• Such a benefit would increase the risk of selective withdrawals.
• Offering such a benefit would increase withdrawal rates, which reduces profitability
• Premiums would need to increase if additional benefits were to be paid, reducing the effectiveness of the product as the cheapest form of life cover.

Question 2

The CEO of the large lic for which you work has read that in EU it has recently been ruled that pricing of life insurance products using gender will no longer be allowed as it has been determined to be discriminatory. He is concerned that this may impact on RSA at some point in the future and has asked for your input.
List the main assumptions used in pricing term assurances and outline how (if at all) their determination might be affected if a similar ruling came into force in RSA. Expenses (incl. commission):

Answer 2

• Would not, in general, be affected by the ruling
• However, there may be a once-off cost associated with communicating the change to policyholders and updating product literature.

Question 3

The CEO of the large lic for which you work has read that in EU it has recently been ruled that pricing of life insurance products using gender will no longer be allowed as it has been determined to be discriminatory. He is concerned that this may impact on RSA at some point in the future and has asked for your input.
List the main assumptions used in pricing term assurances and outline how (if at all) their determination might be affected if a similar ruling came into force in RSA. Profit margin:

Answer 3

• Profit margins may be increased to allow for the increased uncertainty relating to portfolio mix following the introduction of the ruling

Question 4

Your company has an established portfolio of single premium conventional endowment assurances. The company is currently designing a recurring premium unit-linked endowment assurance product.
ii. Describe the profit test model that you would use to determine the charging structure of the unit-linked product.

Answer 4

The model projects expected cash and profit flows for a single policy
These results would then need to be grossed up based on the projected business mix.
The model would need to be able to take different charging structures into account.
The unit fund(s) and non-unit fund would need to be projected.
The model would need to make an allowance for the surrender benefit and possible zeroisation of negative non-unit fund cashflows after year 1 as well as any actuarial funding.
The net projected cashflows would then be discounted at a risk discount rate reflecting the required return on capital and the risk attaching to the cashflows.
The profit may be measured as a net present value, profit margin, internal rate of return or discounted payback.
The model may be stochastic or deterministic.

Question 5

• Risk Characteristics cross subsidies

Answer 5

 Any cross-subsidy in a product design increases risk because actual experience may be different to the assumption on the extent of cross-subsidy, e.g. we may get more smokers buying the product than assumed when we priced the product.
 The shareholders appetite for this additional risk should be considered.
 Some additional risk management measures may have to be introduced, e.g. limiting the maximum sum assured per policyholder.
 The company may want to consider a quota share reinsurance arrangement to share the business mix risk.

Question 6

• Marketability: cross subsidies

Answer 6

 Potential policyholders may not like the idea that they may be cross-subsidising others in terms of health.
 However:
 Simplifying the design (e.g. the age bands) means that the product is more marketable.
 A simplified underwriting process, may also reduce new business administration.
 The product designer needs to weigh-up the benefit of simplicity against the additional risk due to the cross-subsidy.

Question 7

• Competitiveness: cross subsidies

Answer 7

 There may be existing products in the market.
If our company’s design is different to the market:
 We may expose ourselves to being selected against, e.g. if competitors’ do not cross-subsidise between ages, we may end up with the older policyholders.
 The product may also be less marketable, e.g. if it is more complicated because we try to limit the cross-subsidies in the product.

Question 8

• Guarantees: cross subsidies

Answer 8

 As premiums are guaranteed risk is increased, because the company will not be able to take corrective action of actual experience wrt cross-subsidies is different to expected.

Question 9

• Consistency with other products the company is already writing: cross subsidies

Answer 9

 If the company is selling a fully-underwritten version of this product, it may expose itself to selection risk if the healthier lives choose the alternative product.

Question 10

• Regulatory requirements /professional guidance: cross subsidies

Answer 10

 May prevent a company from differentiating by some risk factor, e.g. gender.
 Forcing the life assurance company to accept the cross-subsidy risk.