Pricing And Financing Strategies

Question 1

Cost vs price

Answer 1

Premiums/contributions should be calculated by equating the value of premiums with the value of benefits and expenses plus a contribution to profit. This should be adjusted for:
• tax
• commission
• cost of capital
• contingency margins
• options and guarantees
• provisioning bases
• experience rating
• investment income
• reinsurance costs

The price of benefits is the amount that can be charged under a particular set of market conditions and may be more or less than the cost. Factors influencing the price include:
• the distribution channel used
• the level of competition in the market
• the approach taken to expense and profit loading (e.g. marginal costs, loss-leading)
• the provider may have a captive market that is not price sensitive

Once a price is determined, it should be profit tested and market tested

Question 2

Incidence of money paid in

Answer 2

Main methods of financing benefits:
• pay as you go (unfunded)
• funded
> lump sum in advance
> terminal funding - funds expected to meet the cost of a series of benefit payments set up as soon as the first payment starts (covers all future benefits)
> regular contributions
> just in time funding - triggered by external event
> smoother pay as you go

Choice of financing strategy might depend on:
• whether the government has used the tax system to make some approaches to financing more advantageous than others
• the way in which the approach to the incidence of funding affects the allocation of risks between the individual and the company

Question 3

Defined benefit pension schemes - amount of contributions

Answer 3

The calculated contribution rate is typically set to meet the value of future benefits and expenses

The actual contribution rate may be different to the calculated rate:
• so as to rectify any shortfall or surplus in the pension scheme
• to reflect the sponsor’s desire to pay less or more into the scheme
• due to legislative constraints