General business environment (11-12)

Question 1

Two approaches to taxation

Answer 1

1. Tax on annual profits (profit = excess of change in assets over change in liabilities)
2. Tax on investment income

There may also be tax on premium income

Question 2

The Profits tax approach

Answer 2

• Taxable profit = increase in free assets over the year
• free assets = assets - liabilities
• Supervisory reserves used - since it limits the insurer’s freedom to manipulate the reserves.
• Supervisory reserves are also fair, since insurer can only distribute profits which are earned in excess of the supervisory reserves.
• Profits distributed to with-profits policyholders are excluded from the calculation

Question 3

Investment Income Tax approach

Answer 3

Taxable amount = investment income and capital gains – operating expenses
* This approach won’t work with TA business (small fund build-up and thus small returns)
* Regulatory environment may decide whether unrealised gains must be included in the income figure or not

Question 4

The Effect of the Fiscal regime

Answer 4

• Different type of life insurance business may be taxed by different methods
• meaning it can be lower cost for consumer if certain form of benefit can be offered as one type of business rather than another
• tax treatment can make life insurance business can make it more or less attractive than other savings contracts
• tax concessions may make the sale of certain types of contracts easier
• tax treatment in the hands of p/h of policy proceeds can distort buying habits
• Contract design should make best use of opportunities provided by fiscal environment

Question 5

Name the different distribution channels

Answer 5

• Insurance intermediaries (Fin adv)
• Tied agents
• Own sales force
• Direct marketing

Question 6

Propensity of consumers to purchase products

Answer 6

• depends upon an interaction between the natural inclination of the consumer to buy and the power of the insurer to sell.
• power = knowledge and information

Question 7

Propensity of consumers to purchase products
Policy sold does not meet needs, what are the risks?

And how are they minimised?

Answer 7

• persistency risk, and consequent financial losses (early lapses)
• Reputational risk - marketing risk - less new business, more lapses, risk of insolvency = inadequeate rpemiums to cover fixed expenses

minimised by:
- sales process clearly documented
- policy literature clearly explained
- insurers and salespeople adopting a fully professional approach

Question 8

The main distribution channels

Insurance intermediaries

Answer 8

• salespeople who must act independently of any particular life insurance company (although they can be owned by one).
• Their aim is to find the best contract, in terms of benefits and premiums, for their clients.
• remunerated, via commission payments, by the companies whose products they sell, or they may alternatively receive a fee from their clients.
• It will often be the client who initiates the sale. However, intermediaries are likely to promote themselves existing clients by, for example, instigating a periodic review of finances.

Question 9

The main distribution channels

Tied agents

Answer 9

• salespeople who are “tied” to one, or sometimes several, life insurance companies
• offer to their clients only the products of those companies.
• employees of a bank or other similar financial institution.
• Where the tie is to more than one company, it will sometimes be the case that the product ranges of the companies are mutually exclusive, but more often there will be an overlap.
• remunerated by the companies to which they are tied. The remuneration could be in the form of commission payments or by salary plus bonuses.
• client who will initiate the sale, but some tied agents may actively engage in selling.

Question 10

The main distribution channels

Own salesforce

Answer 10

• Members of an own salesforce will usually be employees of a life insurance company and hence will only sell the products of that company.
• They may be remunerated by commission or salary or a mixture of both.
• salesperson who initiates a sale, making use of client lists.
• once the salesperson has built up a rapport with a particular client, it will then often be the latter who initiates further sales.

Question 11

The main distribution channels

Direct Marketing

Answer 11

• mailshots: LI initiates sale
• telephone selling: LI or p/h initiates the sale
• press advertising: debateable
• internet selling: simple product for online quotes / p/h initiates the sale

Question 12

The effect of different distribution channels

List

Answer 12

• Demographic profile
• Contract design
• Pricing

Question 13

The effect of different distribution channels

Demographic profile

Answer 13

Class selection
-“Class selection” simply refers to the fact that people can be usefully classified by certain attributes that affect their mortality or sickness experience.
- Different channels are likely to appeal to different people
- according to their level of financial sophistication and level of income.
- These differences will then be reflected in the resulting demographic experience of the lives taking out contracts through each channel.
- The levels of income and financial sophistication of the customers will tend to be correlated with their mortality, sickness and withdrawal experience.

Withdrawal experience
- differences in terms of aggressiveness of the selling approach, the extent to which customer needs and ability to pay are considered, and who initiates the sale.

Question 14

The effect of different distribution channels

Contract design

Answer 14

• the higher the level of financial sophistication of the client base the greater can be the complexity of the products being sold.

Question 15

The effect of different distribution channels

Contract pricing

Answer 15

The effect on demographic assumptions
- level of underwriting exercised will depend on the marketing strategy used
- II>TA>OS>DM
- II might encourage anti-selection
- Withdrawal rates are likely to be affected by the level of financial sophistication and whether it was the policyholder who initiated the sale

The effect on the need for competitive terms
- II>TA>OS>DM
- Insurance intermediaries will recommend to their clients the companies with the most competitive rates, other things being equal.

Question 16

How can the control cycle influence the management of a life insurer’s sales distribution?

Answer 16

• The company needs to choose a distribution strategy which should help it to meet its targets for future profitability whilst maintaining an acceptable level of risk.
• The choice of distribution channels will affect a number of important assumptions in the company’s projection models.

Macro Decision-making:
* Companies decide on distribution channels for future profitability and risk management.
* Market analysis and competitor strategies guide this decision.
* Distribution choices affect business projections, including sales volume, pricing, and demographics.
Modeling and Strategy Development:
* The chosen strategy should align with modeling outcomes.
* Consideration of costs and risks is crucial, especially regarding uncertain variables.
Continual Analysis:
* Regularly analyze the current distribution strategy to ensure it matches projections.
* Adjustments may be needed based on performance compared to expectations.
Micro-level Optimization:
* Continuously improve within the chosen strategy by analyzing individual sales outlets.
* Identify areas of poor performance and implement improvements.
Professionalism in Sales Distribution:
* Uphold ethical practices and prioritize consumer interests.
* Avoid unethical selling methods and rectify instances of poor practice.
* Foster a culture of good practice within the company.

Question 17

Types of expenses and commissions including influence of inflation

Name each type

Answer 17

Commission:
- initial comm on acquisition of a new policy (may be recoverable on early lapses)
- renewal comm on renewal

Management Expenses:
- new business
- in-force business
- claims
- overheads (regardless of business vols)

Influence of inflation:
- profitability risk = Actual expenses>expected and loadings are insufficient
- inflation affects underlying costs

Question 18

Economic environment

Answer 18

Insurer:
- availability of asset types
- short and long term expected yields
- more volatile investment markets = more expensive insurance products and less takeup
- higher capital requirements due to increased uncertainty of return

P/h:
- insurance product may be seen as more or less attractive compared to other investments/no investment

Question 19

Legal environment

Answer 19

• politically stable environment where legal processes of contract lawe operate efficiently = the written contract between insurer and policyholder should normally avoid any significant legal risk
• particular care needed: part of contract where insurer has discretion
• UCT voiding clauses of a contract (e.g. increases in charges)
• product design in influenced
• biggest risk: new legislation introduced
• misadvertising: risks may arise from inconsistencies between the policy document and any other relevant representations made by the company or its agents.

Question 20

Regulatory constraints and opportunities

Answer 20

• Governments may impose restrictions on the way that life insurance companies operate.
• The aim of such restrictions is usually stated to be the protection of the policyholder.

types of restrictions:
* types of contract LI companies can sell
* on charges, premium rates that can be used for some types of contracts
* on rating factors that can be used to calculate premiums
* relating to T’s and C’s of contracts offered (calculation methods of paid up and surrender values)
* on distribution channels or requirement on sales process and information required to be given
* on ability to underwrite (no use of genetic testing) NZ: no one may be denief life insurance
* constraints on the amount of business that may be written (through solvency capital and supervisory reserves)
* investment restrictions: type of asset, amount of particular type of asset, extent of mismatching

wider regulatory environment:
- Life insurance companies typically dominate pure protection benefits but not savings benefits.
- Other savings options include unit trusts, investment trusts, mutual funds, and direct investment in assets.
- Regulatory controls for banks and life insurance companies differ, leading to uneven competition.
- Regulatory differences may affect capital adequacy, advertising rules, and benefit illustrations.
- Regulatory environment influences contract design for life insurance companies, balancing opportunities and constraints.

Climate change related regulations
- Policymakers and regulators are concerned about climate change’s impact on the financial system.
- The financial system plays a crucial role in transitioning to a low-carbon economy.
- Financial institutions can aid this transition by investing in green technologies.
- Regulations are being developed to ensure disclosure of climate-related risks and consistent risk management.
- Many insurers have voluntarily committed to addressing climate change.
- Future regulations may mandate action for all insurers.
- Initiatives like the net-zero asset owner alliance aim for carbon neutrality by 2050.

Question 21

The effect of the fiscal regime

Answer 21

• different types of LI business may be taxed by different methods
• therefore: can be lower cost to consumer if certain form of benefit can be offered as one type of business rather than another
• tax treatment can make LI more or lass attractive than other savings methods
• tax concessions may make the sale of certain types of contracts easier
• product design will want to make the best use of opportunities
• taxation risk: tax can change over time, so keep in mind when benefits are guaranteed over the long term

overall aatractiveness of LI product depends on tax treatment of:
1. premiums paid
2. life insurer’s fund during life of policy
3. the eventual benefits paid

Question 22

Professional guidance

Answer 22

• Actuarial associations issue professional guidance for actuaries advising life insurance companies.
• may also issue professional guidance on the interpretation of government regulations.
• To the extent that professional guidance adds safeguards as to the proper running of life insurers, it effectively provides an opportunity for insurers to encourage consumers to invest in life insurance products.