Q&A Bank P2

Question 1

what is meant by work site marketing

Answer 1

either the insurance intermediaries or the company’s own sales force will carry this out.

an employer allows access to the work force through meetings or literature for the purpose of marketing products to the employees on an individual basis

Question 2

how do insurance intermediaries operate?

Answer 2

these are independent of any particular insurer.

the can advise their clients on the best contracts for their needs from among all the contracts available.

they may be remunerated by commission from the insurer whose products they sell or by fees from clients

Question 3

how do tied agents operate?

Answer 3

these are insurance intermediaries who offer the products of only one or a limited number of insurers.

if they are tied to more than one insurer then usually the product ranges of the companies are mutually exclusive.

typically, tied agents are financial institutions such as banks or building societies.

they are paid commission by the companies they are tied to.

Question 4

how does own sales force operate?

Answer 4

these are usually employees of an insurer and so only sell products of that insurer.

they may be paid by salary, commission or both.

Question 5

how does direct marketing operate?

Answer 5

telephone selling may involve cold calling by the insurer or might be in response to an advert.

press advertising might include an application form or invite requests for further information .

mail shots will include application forms

internet selling may be linked to advertising and is essentially web based application processing.

Question 6

give examples of 4 external parties to a health and care insurer whose activities may cause losses to the insurer

Answer 6

• reinsurer
• distributor
• treatment provider, e.g. hospital
• third party insurance specialist, e.g. underwriter or claims assessor.

Question 7

why might the actions of a reinsurer cause losses to a health and care insurer?

Answer 7

the direct writer is fully liable for any claim payments due, even if it is unable to make the anticipated reinsurance recoveries.

Question 8

why might the actions of a distributor cause losses to a health and care insurer?

Answer 8

a broker may delay the return of premiums due to the insurer or become bankrupt before these premiums are returned.

a distributor may commit the insurer to conditions that were not the original purpose of the contract .

a distributor may bring the insurer into disrepute in their dealings with clients.

Question 9

how can the insurer reduce the risks of the actions of a distributor

Answer 9

• instate premium return claw backs
• minimise risks by ensuring that a good relationship is maintained with distributors through adequate communication and training.
• minimise the premium risk by insisting that brokers balances are kept to a minimum and diversifying - not relying heavily on a small number of brokers.

Question 10

how can the insurer reduce the risks of the actions of a distributor

Answer 10

• instate premium return claw backs
• minimise risks by ensuring that a good relationship is maintained with distributors through adequate communication and training.
• minimise the premium risk by insisting that brokers balances are kept to a minimum and diversifying - not relying heavily on a small number of brokers.

Question 11

describe the ways in which reinsurance can affect product pricing

Answer 11

• reinsurance will usually have a net cost to the insurer, reducing the expected profitability of the contract.
• reinsurance generally reduces risk to the insurer
• reinsurance can help reduce the companies financing requirement.
• the reinsurance agreement may specify the price that the insurer has to charge for a product, e.g. when a quota share will a low retention level is used.

Question 12

-the reinsurance agreement may specify the price that the insurer has to charge for a product. expand re product pricing

Answer 12

e. g. applies when a quota share will a low retention level is used.
- any profit sharing agreements may affect the expected profit and hence the price that can be charged

Question 13

-reinsurance can help reduce the companies financing requirement. re product pricing

Answer 13

• this will reduce the cost of capital and should also reduce the product price
• it may also allow more business to be written
• reducing the price may also have the effect of increasing sales so resulting in higher total profits.

Question 14

-reinsurance generally reduces risk to the insurer. re product pricing

Answer 14

• this means that the product can be priced with more certainty and so the margins in the basis to cover risk , e.g. the risk discount rate, so not need to be so large.
• this will help reduce the product price

Question 15

-reinsurance will usually have a net cost to the insurer, reducing the expected profitability of the contract. expand re product pricing

Answer 15

• the product price may therefore need to be increased to reflect this cost
• due to arbitrage possibilities it may be that the reinsurance can lead to increased profit for the insurer
• this could result in a reduction in product price

Question 16

state when case estimation is more suitable than statistical estimation of claims reserves

Answer 16

case estimation is more suitable than statistical estimation when

• sufficient qualitative data is available for each individual claim
• and there is an experienced team of claims assessors
• insufficient historic data for statistical methods
• relatively heterogeneous type of claims
• a new class of business
• high variance in the claim amount
• no appropriate statistical model available

Question 17

list and define the types of reserves held for individual non linked annual premium CI policies

Answer 17

reserves in total will be small for this business since it is a protection contract with little need to build up a fund.

however if the benefits are very likely to be paid(high claim frequency) and the contract is more of a savings contract, then reserves could be larger.

• reserves for policies
• reserves for claims
• options reserves

Question 18

define the reserves for policies held for individual non linked annual premium CI policies

Answer 18

this is the discounted value of future cash outgo, i.e. the expected pv of future claims plus expenses less premiums and it will be the majority of the reserves, since the funds plus premiums are held to meet the benefits paid out in future.

Question 19

define the reserves for claims held for individual non linked annual premium CI policies

Answer 19

this is the discounted value of claims that have arisen but have not yet been settled, i.e the expected pv of the claims + expense.
this includes:
-claims that have been diagnosed but not yet reported (IBNR) which could be substantial if claims take time to be reported
- claims that have been reported but not yet settled, which should be small unless there are significant delays in paying claims due to a lengthy claims verification process for certain illnesses.

Question 20

define the option reserves held for individual non linked annual premium CI policies

Answer 20

this is in respect of additional costs that need to be set aside for the eventuality that a particular options becomes more valuable if it is exercised than if it is not.
such options might include the option to increase the sum insured or extend the term of the policy.

Question 21

explain the principal concerns for the marketing manager in assessing the proposed product design and pricing of a new health and care insurance product

Answer 21

the marketing manager will be primarily concerned with the attractiveness of the proposed contract to the target market and the sales force since it is often the case that the salesman represents the main hurdle to the acceptability of the product.

the concern will extend to issues such as:

• perceived value for money of the product to the market
• competitive product terms
• how well the product meets the needs of the target market
• any unique selling points preferably at no extra cost
• the absence of explicit charges - such as reduced allocation period for unit linked contracts
• attractive commission for sales force and ease of selling
• easily comprehensible and clear design

Question 22

explain the principal concerns for the valuation actuary in assessing the proposed product design and pricing of a new health and care insurance product

Answer 22

• the use of existing pricing and reserving methods
• not to be overly risky e.g the guarantees and options not being too onerous and are claims definitions watertight
• whether the extent of any cross subsidies leads to acceptable risk e.g. from unexpected changes in the mix of new business
• setting sufficient premiums or charges to ensure adequate profitability and return on capital
• ensuring that profit is not too sensitive to changes in conditions by making charges and premiums reviewable
• minimising new business strain or ensuring that there is enough capital to cover future new business volumes
• a speedy return of initial capital
• adequate uw standards and claims control
• ease of reporting and record keeping - including supervisory reporting
• the effects of other business both existing (lapses) and on sales of new business for other products
• fully established admin computer systems

Question 23

state when a risk margin may be applied when stetting market consistent reserves

Answer 23

a risk margin may be applied where it is difficult to obtain MC assumptions for some elements of the basis such as morbidity, persistency or expenses.

this is because a sufficiently deep and liquid market in which to trade or hedge such risks does not exist.

there is not a market big enough so that large trades would not materially affect the prices.

in such case a RM would be included in respect of such assumptions due to the inherent uncertainty.

Question 24

what does a risk margin reflect in MC reserving

Answer 24

the RM should reflect the compensation required by the market in return for taking on those uncertain aspects of the liability cashflows.

Question 25

state 2 alternative methods for applying a RM for MC reserving

Answer 25

1. a margin could be added to each assumption for which there is inherent uncertainty
2. an overall reserving margin could be determined using the cost of capital approach.

Question 26

give a formula for an overall RM

Answer 26

RM = ∑[(kt*Ct)/(1+rt)^t]

kt is the cost of capital charge for time t
Ct is the required capital at time t
rt is the risk free interest rate for maturity t

Question 27

determining the RM using the cost of capital approach

projection of capital

Answer 27

the coc method involves first projecting forward the future capital that the company is required to hold at the end of each period during the run off of the business.

the projected capital is the amount required to be held in excess of the projected liabilities at each period.

calculation of the projected capital might require complex projections, stochastic modelling, correlation matrices and should be determined according tot he relevant regulatory basis.

however, regulations may permit use of a simplified approach, which might involve selecting a driver which has an approx linear relationship with regulatory capital also that the projected capital can then be approximated as a percentage of the projected values of the driver.

Question 28

determining the RM using the cost of capital approach

cost of capital charge

Answer 28

these projected capital amouhnts are then multiplied by a cost of capital rate.

this rate represents incremental capital in excess of the risk free rate alternatively, it represents the frictional cost to the company of locking in this capital to earn a risk free rate rather than beign able to invest it freely for higher reward.

it can be calculated as teh excess fo the weighted average coc over the risk free rate.

it may be dependent on the time period being considered or iti may be a specified fixed rate e.g. 6% per solvency II

Question 29

how does the choice of bonds affect the discount rate used to value the liabilities in a MC valuation

Answer 29

in a MC valuation, the discount rate would usually be the risk free rate obtainable on government bonds regardless of the choice of assets.

however, an illiquidity premium can sometimes be included in the discount rate used for the liabilities to take credit for the illiquidity premium in the yield on the assets held.

a higher discount rate will lead to a lower value of liabilities and so a better solvency position.

Question 30

what are the circumstances appropriate for holding an illiquidity premium

Answer 30

if the insurer has chosen a to hold government bonds, it will not be able to include an illiquidity premium in its discount rate.

if the insurer has chosen to hold a corporate bond then it may be able to include an illiquiditity premium, if this is permitted by legislation.

it is only generally appropriate to include an illiquidity premium for long term predictable liabilities which will be the case if the insurer has a large enough portfolio to remove random fluctuations from the experience.

Question 31

list the items that would be used in a cashflow profit test to price non linked individual CI on guaranteed terms sold through IFA’s

Answer 31

premiums
benefit payments
claim incidence rates
mortality rates
lapse rates
expenses
expense inflation
commission 
investemtn return
tax 
mix of new business where there are cross subsidies
new busniess volumes for expense loadings
profit criterion
risk dicount rate
reserving basis 
solvency capital required

Question 32

state what is meant by the NPV of a contract and how it would be calculated

Answer 32

the npv requires the calculation of the profit signature for a given model point

the profit signature is the expected future profit stream that would be generate by a single long term policy

the first step is the projection of future cashflows, these being the difference between income (premiums, charges, investment returns) and outgo (expenses, claims costs and tax)

the annual cashflows will be reduced by the expected cost of increasing the supervisory reserve each year and increased by the investment returns earned on the reserves.

the future profit flows are then adjusted to allow for future survival and w/d to produce the profit signature.

the NPV is the discounted value of the profit signature at the rdr

Question 33

what are the disadvantages of using NPV as a profit criterion

Answer 33

• it is subject to the law of diminishing returns.
• it says nothing about compettiion at all. there is no point in designing a contract with a high NPV if it cannot be sold.
• it does not dsitinguish between policies tha have a very different initial capital requiremetns and hence may have very different DPPs

Question 34

when are comparisons based on the NPV valid

Answer 34

comparisons will only be valid if

• there is a perfectly free and efficient capital market, which is never exactly true
• the rdr used to discount 2 or more risky investments reflect the riskiness appropriately, which may be difficult to assess.

Question 35

the NPV is subject to the law of diminishing returns. expand

Answer 35

if it weren’t, then an insurer that could sell 1 policy with positive NPV could sell an unlimited number of policies and increase the value of the insurer without limit.

so even a marketable and competitive product would run out of customers once the market is saturated and the cost of increasing sales becomes increasingly prohibitive.

Question 36

why is NPV more reliable than IRR

Answer 36

• if there is more than one change of sign in the stream of profits in the profit signature, the IRR will not usually be unique
• the NPV can be related to useful indicators of the policy’s worth to the company in terms of sales effort or market share. this cannot be done with the IRR
• if a policy makes profits from the outset then the IRR may not exists. NPV always exists.