Life insurance products (1) Flashcards
Describing the main types of life insurance products, their benefits and the bases they're written on
Generally define
Life insurance products
In return for one or more premiums paid by the customer, the insurer constract to pay benefits which are in some way contingent upom human life.
Describe the
Needs met by Life insurance contracts
3 main points to consider
- Savings
- Protection
- Savings and Protection
Define
New Business strain
The combination of the initial cash outflow, any prudence in the reserves and the need to establish a required solvency margin means that moeny has to be found initially in order to write new business
Describe
The personal financial life cycle
Describe
The product cycle
Endowment assurances
The needs of consumers
Definition first, then how it meets needs
Pays benefit on survival to a known date
- savings: lumpsum on retirement or repaying capital on interest only loan
- protection
- transfer of wealth
Endowment assurances
Surrender value
Existence and form
- Typically available
- product design desicion
- may ot be related to death or maturity benefit
- usually increase over time
Endowment assurance
Types
- without-profit
- with-profit
- unit-linked
List
The factors that affect the level of capital requirements
There are 5
CLAPP
Contract desing
Level of intial expenses
Additional solvency capital requirements
Pricing and reserving bases relationship
Premium payment frequency
Endowment assurances
Group version
- a way for an employer to provide some form of insurance cover or savings benefit to employees as part of their overall remuneration package
- would enable an employer to provide benefits for empoyees at retirement and maybe also on death in service
- administration can become costly due to mobility of the workforce
- might result in poor suurende values for employees that leav early
Endowment assurances
The risks
Investment risk
- Due to savings nature
- without-profits: benefit is guaranteed, therefore high risk that investment returns are lower than allowed for in premiums
- with-profits: lower risk, since bonuses can be reduced if returns are lower than expected, however, there is still a guaranteed element, PRE, shareholders’ RR, marketing
- unit-linked: risk is borne by policyholder, however charges are linked to fund size, damage to future sales
Mortality risk
- Death = survival benefit: high mortality risk at start
- Death benefit = return of premium or fund: insigificant risk, except near start of contract
- no death benefit: longevity risk, with increasing significance over duration in force
Expense risk
- risk that actual marginal and fixed costs are higher than expected/allowed for in premiums or charges
Withdrawal risk
- risk that number of withdrawals are different than expected
- when asset share is negative: there is financial risk from withdrawal
Risks under group contracts
- adds no additional risks
- anti-selection risks are reduced (compulsory cover and restrictions on the level of cover)
- concentration risk may arise
Endowment assurances
Capital requirements
Contract design
- whether design enables reserves and solvency margins to be kept low
- lower initial reserves = lower capital requirements
- slower increase in reserves over the contract’s term = faster invested capital is released
Level of initial expenses:
- higher expenses = lower initial asset share = higher capital requirement
Additional solvency capital requirements
- inverse relationship between level of solvency margin and supervisory reserves
Premium payment frequency
- capital requirements for:
monthly > annual > single premium
Pricing and reserving bases
- the stronger the reserving basis compared to pricing basis, the more cpaital is needed
A company is likely to prefer contract types and designs that recoup the invested capital quickly. Suggest why premiums (or charges) are often level or even gradually rising during the policy term.
- Unmarketable - does not meet needs of the publick
- Public expectations based on company’s past practice
Endowment assurances
Customer needs
and why it’s attractive
- Provide a defined benefit on survival to a known date: savings vehicle
- Provide a benefit on death before maturity: protection for dependants
- repay capital on interest only loan.
Endowment assurance ensures a significant wealth transfer at death or maturity, unlike non-insured savings, which only accumulate paid contributions.
Endowment assurances
Surrender value
- Typically available
- May be related to maturity or death benefit
- Or could be portion of premiums paid
-SVs usually increase over the term of the contract
Endowment assurances
Types
and which is more expensive
Without profits: guaranteed sum assured for single or regular premium
With-profits: initial sum assured enhanced by bonuses declared.
The premium for the with-profits contract should be larger, for the same guaranteed SA. Because the with-profits premium is set to provide an expected benefit that is much larger than the initial guaranteed amount
Unit-linked: paying policyholder premiums into pooled investment funds. The benefit payable at maturity depends on the performance of the underlying assets and the level of charges levied by the insurance company. Benefit defined as minimum of funds or guaranteed amount (protection) or as percentage of funds (for savings).
SV reduced by surrender penalty.
When using an endowment to pay off a loan, a with-profits policy is much more often used than a without-profits policy. Why?
- With-profits endowment policies have higher premiums but the potential for better returns through bonuses.
- Risk: Future bonuses are not guaranteed, creating uncertainty for policyholders relying on them to pay off loans.
- UK impact: Mis-selling concerns led to a decline in endowment mortgages.
- Non-profit version: Safer alternative, avoiding bonus uncertainty and third-party insurer risk.
- Comparison: A standard repayment mortgage with decreasing term assurance is often more cost-effective.
Endowment assurances
Group products
and problem
A group endowment assurance would enable, for example, an employer to provide benefits for employees at retirement, and maybe also on death in service.
The main problem would be mobility of the workforce: the administration of such an arrangement would become costly and mey lead to poor surrender values.
Endowment assurances
Risks
Investment risk
- Without-profits: Insurer bears full investment risk since benefits are guaranteed. Poor returns lead to losses.
- With-profits: Insurer can reduce bonuses, but guaranteed elements and policyholder expectations still pose risks. Poor returns may also impact shareholder profits and future sales.
- Unit-linked: Policyholder bears investment risk, but insurer faces indirect risks through reduced fund-based charges and potential sales decline if performance is poor.
Mortality risk
- Large death benefit: high mortality risk at start of contract due to high sum at risk
- anti-selection risk: depending on the extent of the actual, or perceived, choice the policyholder had in effecting the contract.
- Return of premiums or “fund”. The mortality risk is likely to be insignificant except near the start of the contract.
- No death benefit. Here there will be a longevity risk, the significance of which will increase with duration in force.
Expense risk
- the risk is that the total actual expenses (over a period) are higher than the total contributions received towards those expenses from the charges and/or premiums received by the company.
- higher than expected price inflation, or because of lower than expected sales of business
Withdrawal risk
- risk that the number of withdrawals is different to that expected
- When the asset share is negative, there is a financial risk from withdrawal.
- At other times, depends on how any withdrawal benefit paid compares with the asset share.
Endowment assurances
Group product Risks
The group version of the contract adds no additional risks and any anti-selection risk is likely to be much reduced, particularly if it is compulsory for all eligible members to join the group contract, and there may be restriction on level of cover (related to salary).
Grouped nature of the contract does mean that a concentration of risk may arise.
Endowment assurances
Capital requirements
- Capital requirement factors:
Contract design:
- Lower reserves reduce capital needs, enabling faster capital release.
- Unit-linked contracts can be highly capital efficient if early premiums are not allocated to unit funds, reducing supervisory reserves and solvency margin requirements.
Premium payment frequency:
- Monthly premiums require the most capital, as only one installment is received initially while expenses are high.
- Annual premiums require less capital than monthly but more than single premium.
- Single premium contracts need the least capital since all premiums are received upfront, reducing capital strain.
Pricing vs. reserving basis:
- If reserving basis is stronger than pricing basis, the premium appears insufficient, requiring extra capital to meet reserve requirements.
- If reserving basis is weaker than pricing basis, the premium exceeds reserve needs, allowing immediate profit release.
Solvency capital requirements:
- Insurers must hold assets covering supervisory reserves + solvency capital.
- Some countries require high reserves but low solvency capital, while others have lower reserves but higher solvency capital.
Initial expenses:
- Higher expenses reduce the initial asset share, increasing capital requirements.
- If pricing anticipates high initial expenses, expected future premium loadings can offset capital strain.
- In practice, regulatory restrictions may prevent full reserve adjustments, and actual expenses may exceed expectations, leading to real losses.
DRAPE
