Product design (20) Flashcards
Product design factors (20)
SAMPLE DIRECT FACTORSS
Sensitivity of profit
Administration systems in place
Marketability
Profitability
Level/form of Benefits
Expenses and how they are allowed for
Discontinuance terms
Interests and needs of policyholders
Risk characteristics
Experience overseas
Competitiveness
Taxation
Financing requirements
Accounting standards
Consistency with other products
Timing of contributions
Options and guarantees
Regulatory requirements
Stakeholder
Subsidies (cross) extent
To what do these factors apply?
- new products
- assessing continuing validity of an existing product
- assessing the appropriateness ony proposed modifications to existing products
Profitability
Premiums on non-unit linked contracts should cover:
1. Benefits
2. expenses in most foreseeable circumstances
3. profit margin
Should ideally be profitable in the different dimensions:
* Savings: Investment income – Actuary should set interest rate in premium basis at an appropriate level
* Protection: mortality risk should be covered by mortality assumptions in premium basis
* Administrative: Expense loadings should cover marginal acquisition and administrative costs. Total expenses should also be covered by total expense charges
Unit-linked: charges should be sufficient to cover expenses, mortality costs and provide profit margin
Exception – loss leader
In an exam question: consider what could impact the profitability
An example of a product where allowance fot expected future mortality change is essential
Deferred annuity contract where the mortality rates post-vesting are guaranteed at policy inception.
total period between inception and vesting can be over 30 years, during which mortality is likely to improve significantly.
Improved mortality = more expensive annuities
Marketability
The benefits offered need to be attractive to the market in which the contract will be sold
- innovative design features make a contract more attractive
- options and guarantees may make a contract more attractive
- charging structure on unit-linked contracts should be attractive to market
- consider whether charges should be guaranteed
- consider guarantees regarding premium rates
- products need to be understandable with no lack of clarity: dependable on distribution channel
- consider distribution channel and whether dual pricing would be used
- How much risk is transferred from the policyholder to the insurer
- Will the product indemnify the policyholder?
Competitiveness
Company will not want the structure and level of charges to depart too far from those of competitors
- but it depends on how it will market the contract
- some distribution channels are more price sensitive than others
- need to fund a level of charges that will maximise total contribution to overheads
Last point: By reducing charges to below the requried level to cover overhears, but above the elvel of covering marginal costs, the pricing will be competitive and they will hope to sell more policies. by selling more policies, the contributions might be sufficient to cover overheads
Financing requirement
Will want to design benefits and charges so as to minimise its financing requirement
(unless it has subtantial capital resources)
- more scope to achieve this under unit-linked vs others
- esp important for new LI companies with little free assets
advantges of UL:
- no or few expense, mortality and investment return guarantees
- possilbly smaller supervisory solvency margin requirement
- decide the extent to which the risk charges will be variable as this will impact on risk and financing requirements
Actuary will use model office techiniques to projection fiancial situation with and without the new product to determin ability to finance the new product and whether return on capital is adequate
To reduce capital strain on non UL:
- reducing initial acquisition costs
- reduce admin expenses
- reducing valuation strain via reduction of guarantees and/or increasing the valuation rate -better earning assets
Risk characteristics
- consider whether the level of risk associated with a proposed contract is acceptable
- which will depend on company’s ability to absorb or reinsure risk
- Consider anti-selection risk and the risk of selective withdrawals
- Lapse and re-entry risk if new feature/product is only available to new policyholders
To deal with large mortality parameter risk:
- offer contract in UL or reviewable form to avoid long term guarantee
- reinsure large part of the risk
- incorporate ample margins in premium rates
- offer contract as additional rider, rather than standalone
Onerousness of any guarantees
Offering guarantees results in two problem:
- suffer an unexpected cost
- having to reserve for this possibility from the outset, increasing capital strain
- orenousness can be quantified as impact on product profitability under various conditions
To deal with this:
- immunisation for investment guarantees
5 factors which will contribute to the onerousness of an investment guarantee
1. extent of the guarantee (size)
2. volume of business to which is applies
3. period of time for which it holds
4. significance fo reserves for the contract
5. capital available to the company to absorb the initial reserving cost and the possible eventual real cost
Sensitivity of profit
for UL: possible to have a well-matched charging structure that reduces sensitivity of the contract’s profitability to variations in future experience.
- products are more likely to be sensitive to certain risks, the more onerous the guarantees are.
Variables that impinge on profitability and how to minimise sensitivity:
- investment return: no guarantees
- mortality / other relevant contingency: variable charges
- expenses (and inflation): variable charges (company’s discretion)
- withdrawal rates (no guarantees & clawback commission on early withdrawals)
- matching: try to match income with outgo by size and timing
Extent of cross-subsidies
Need to decide on the extent of cross-subsidies between e.g. large and small contracts.
* May conflict with simple premium and charging structure
* Risk of expected business mix not being like expected
* Ideally, each product should cover its own marginal administrative/sales costs
Admin systems
System requirements of new product may limit:
1. benefits to be provided
2. charging structure to be adopted
Another reason why SIMPLICITY is important
Consistency with other products
Charging and Benefit structure of new policy should be at least similar to any existing business.
Why?
- major change will result in significant systems development, taking time
- benefits of saving time and cost considering staff training, marketing literature ens
- a design that appears much more attractive to policyholders, may seem unfair to existing policyholders leading to dissatisfaction and possible marketing risk and may result in many lapses
Regulatory requirements
Company must adhere to regulatory requirements, e.g:
- maximum charges
- TCF
Why TCF?
- to meet notmal standards or professional ethical behaviour
- may be regulatory requirement or recommended by professional guidance
- foster ongoing trust and good relations with p/h, the media, and general public, which helps sales in the long run
Sustainable investment options
ESG: Environmental, Social and Governance
Drivers of ESG issues:
- regulatory
- marketing
- and social responsibility
Co needs to consider sustainable investment options when designing products
Climate change can cause investments in fossil fuels and carbon-intensive industries to fall
Interaction of product design factors
- These factors are not necessarily independent,
- in that meeting one may prejudice the meeting of another,
- and so a compromise will usually need to be reached.
- Also, the factors are not necessarily mutually exclusive.
