Section A Flashcards
Slow Product Development Cycles
- Average launch time is 7-9 months
- Bottlenecks
a) Administration - need to update systems
b) Distribution training
c) Marketing materials
d) Illustration System - Some countries use incentives to motivate the product development team
- Steering committees - help direct the product development process
- Increase IT headcount to improve speed to market
Life Insurance…Innovation and Optimization (LFV-140-16)
Global Insurance Market Trends
- Low interest rates
- Lower profitability due to lower investment income
- Alternative asset classes to boost yields
- Robust premium growth (3.3%)
- Stable underwriting margins
- Changing regulatory landscape (Solvency II, PBR, IFRS)
- Low number of catastrophic events recently - good experience for catastrophic coverage
- M&A activity has increased (Mergers and Acquisitions)
International Association…Insurance Market Report (LP-138-16)
Motivations for M&A Activity
- Enter a new market (cross border, new products)
- Increase size (economies of scale / diversification of risk)
- Response to new regulation
- Capital management
- Horizontal integration
- Vertical integration
- Less opportunity for organic growth
International Association…Insurance Market Report (LP-138-16)
Regulation of Insurance M&A in China
- China regulators are considered with the following:
a. Insurance company solvency position
b. Overall impact on the insurance industry
c. Impact on the customer - Regulators need to approve an acquisition before it can proceed.
International Association…Insurance Market Report (LP-138-16)
Regulation of Insurance M&A in Bermuda
- Pre-announcement - Bermuda Monetary Authority (BMA) should be notified and engaged
- Upon announcement
a. May engage another jurisdiction’s supervisor (if appropriate)
b. Engages with management of the impacted companies - Post shareholder approval - BMA will get progress updates periodically.
- Post-closing of the deal -BMA will monitor integration of companies
International Association…Insurance Market Report (LP-138-16)
M&A in Bermuda Types of Information Regulator Will Review
- Company strategy
- Risk management
- Transaction details
- Business plans
- Plans for integration
International Association…Insurance Market Report (LP-138-16)
Characteristics of Term Insurance
- Term insurance provides protection for a specified period of time
- Coverage Periods and Face Amount Patterns
- Premium Patterns and Premium Guarantees
- Premium differences by policy size
- Premium differences by underwriting class
- Riders
- Options
Life and Annuity Product Features (LP-105-07) Chap 1
Term Insurance Coverage Period, Face Amount Pattern, and Premiums
- Coverage Period – stated number of years or until a given age
- Face amount patterns
a. Increasing – commonly indexed to inflation
b. Level – most common
c. Decreasing – used for mortgage protection - Premiums can increase, decrease or remain level
- Premium scale
a. Attained age scale
b. Select scale
c. Select and ultimate scale - Term premiums are often guaranteed for an initial period and then subject to change
Life and Annuity Product Features (LP-105-07) Chap 1
Solutions for Decreasing Term
Level premium becomes very high in relation to DB
This may cause high lapses in later years
Possible solutions
- Limited payment decreasing term
- Decreasing premium scales
- Make DB level after period of time
- Premium = DB * one-year term rate
Life and Annuity Product Features (LP-105-07) Chap 1
Par Term
High guaranteed premium offset by dividends
Results in a decreasing premium pattern
Advantages of par term
- High gross premiums minimize the need for deficiency reserves
- Premiums provide a cushion against adverse future experience
- Insured’s net outlay may actually decrease in later policy years
- Decreasing or modestly increasing net outlays encourage persistency
- Slope of GP scale can sometimes lower costs by minimizing CV
Life and Annuity Product Features (LP-105-07) Chap 1
Term Insurance
Premium Differences by Policy
Size or Underwriting Class
- Options to vary premium by policy size:
a. Banding
b. Policy fee
c. Could use both banding and policy fee
d. Continuous rate structure – similar to banding but no cliff - Premium discounts for insureds that meet preferred criteria
- Premium discounts for females
Life and Annuity Product Features (LP-105-07) Chap 1
Term Insurance
Riders and Options
- Term insurance is often attached to a permanent policy as a rider
- No policy fee for a term rider
- Term riders on child or spouse provide for small benefits
- Common options in term products
a. Conversion – can convert term policy to a permanent policy
b. Guaranteed insurability option – can increase face amount without evidence of insurability
Life and Annuity Product Features (LP-105-07) Chap 1
Pricing Considerations for Term Insurance
- Mortality
- Lapse Rates
- Underwriting
- Commission
- Expense and inflation
- Pricing options
- Profit objectives
- Legal and regulatory issues
Life and Annuity Product Features (LP-105-07) Chap 1
Pricing Considerations for Term Insurance
Mortality
- Significant factor for term pricing
- High face amounts will lead to good mortality in early years
- The slope of mortality by duration is influenced by:
a. Unhealthy lives extending coverage
b. Healthy insureds finding lower rates
c. Extremely competitive market - Renewal mortality is difficult for increasing term because most exposure is weighted toward later policy durations
Life and Annuity Product Features (LP-105-07) Chap 1
Pricing Considerations for Term Insurance
Commission
- Competition has driven commission rates and 1st year premiums down
- First year commission rates lower than 30% are rare
- Renewal commissions of 5% are typical
- Agents have incentives to replace business frequently
a. Higher commission rates in the first year
b. They can obtain a lower premium for their clients
c. If agent doesn’t replace policy, another agent may steal the policy
Life and Annuity Product Features (LP-105-07) Chap 1
Approach to Charging for Options in Term Products
- Costs are borne by people who exercise the option
- Cost borne by all people who have the option available
- Costs borne by everyone, whether they want the options or not
Life and Annuity Product Features (LP-105-07) Chap 1
Extra Mortality Costs for Conversion
A_{(x,m,r)} \textup{ - PV at age x of extra mortality cost due to conversion at year r}\newline\newline
A_{x,m,r} = ${t}p{x,m}$\times$e_{x,m,r}\times$K_{x,m,r}\times$v^{t} \newline\newline
K_{(x,m,r)} \textup{ - PV at age y of extra mortality cost where y = x + r} \newline\newline
K_{x,m,r}=\sum_{t=1}^{\infty}${t-1}p{y,m,r}\times[q_{(y,m,r)+t-1}-q_{[y]+t-1}]\times$NAR_{y+t}\times$v^{t}
Life and Annuity Product Features (LP-105-07) Chap 1
Term Conversion Lapse Experience
- Decreasing lapses by increasing age at conversion
- First year lapses were higher than renewal lapses
- Lapse rates for “last chance” conversions tended to be lower
- Lapse rates for plans with automatic conversion features were higher
- Female lapse rates higher than male lapse rates
- At younger ages, lapse rates for paramedical business > non-medical business > medical business
- Lapse rates for base policies versus riders varied by product
Life and Annuity Product Features (LP-105-07) Chap 1
Term Conversion Mortality Experience
- Mortality ratios more favorable for policies that converted prior to the end of the conversion period.
- Mortality experience for automatic conversion policies and renewable term plans was very favorable
- Decreasing term plans showed significantly higher mortality ratios
- Female ratios were lower than male ratios
- Select period mortality ratios were lowest for paramedical policies < medical < non-medical policies
- Mortality ratios were higher for term conversions (vs. rider conversions)
Life and Annuity Product Features (LP-105-07) Chap 1
Determining the Cost of Options
LaTeX needed
Life and Annuity Product Features (LP-105-07) Chap 1
Characteristics of UL Products
- Cash Value
- Cost of insurance charge (COI)
- Expense charges
- Surrender charge
- Credited interest rate
- Partial withdrawals
- Persistency bonus
- Current and guaranteed charges
- Funds are deposited into the general account
- Guaranteed minimum interest rate
- Death Benefit Options
- Policy Loans
- Riders
Life and Annuity Product Features (LP-105-07) Chap 2
UL Credited Rate
- Interest rate credited may be declared monthly
- One-year guarantees are common
- Portfolio or new money rates
- Credited Rate = Earned Rate - Spread
- Policy fees have been replaced by only crediting current interest to AV in excess of $x
Life and Annuity Product Features (LP-105-07) Chap 2
Advantages/Disadvantages of Fixed Premium UL (FPUL)
Advantages of FPUL (vs. flexible premium)
- Similar to traditional products
- Policyholder has minimum guaranteed benefits
- Higher premium is used in calculating the commission
- Fixed premiums may enhance persistency
Disadvantages of FPUL
- No premium flexibility
- Additional premiums can complicate administration
- Vanishing premium dependent on interest rates
- Vanishing premium provision is subject to lawsuits
Life and Annuity Product Features (LP-105-07) Chap 2
Advantages of Group UL
- Many states allow expense loads to be changed on a group by group basis
- Multiple employer trusts allow for efficiencies in contract filing
- GUL includes features like experience rating and mortality charges based upon historical experience
- Guaranteed issue limits
Life and Annuity Product Features (LP-105-07) Chap 2
Source of Profit Analysis For UL
CRIES
- Cost of insurance charges less death benefit paid
- Reserve released in excess of AV released
- Interest earned less interest credited
- Expense charges less expenses and commissions
- Surrender charges
Life and Annuity Product Features (LP-105-07) Chap 2
VUL has similarities to UL and Fixed Premium Variable Life
Similarities to fixed premium variable life include:
- Separate accounts
- Several investment options
- Sales loads may be limited by regulation
- Other charges may be limited
Similarities to UL
- Flexible premium payments
- Death Benefit Types 1 & 2 are available
- Changes in DB allowed
- Monthly charges
- Charge for riders deducted from fund
- Combination of front and back-end loads
- Commissions based on more than one factor
Life and Annuity Product Features (LP-105-07) Chap 3
Types of Fixed Premium Variable Life
- Dutch Design
a. Not currently in use by a U.S. company
b. Simplest design, but required premiums vary over time
c. DB / premium constant in # of shares - New York Life Design
a. LaTex needed DB = Face(0)*(actual CV / tabular CV)
b. CV tabular is the CV if separate account earns exactly the AIR (Assumed Interest Rate) - Equitable Design
a. Used by almost every company in the US
b. LaTex needed DB = Face(0) + (Excess of investment performance over AIR)/A(x+t)
Life and Annuity Product Features (LP-105-07) Chap 3
Characteristics of Survivorship Insurance
- Pays death benefit on the second death
- Can take the form of UL, traditional par WL, and excess interest WL
- Single Status vs. Dual Status
- Joint age calculation
- Substandard and uninsurables
- Flexibility is important – death benefits and premiums
- Competitive, sophisticated, affluent market
- Common riders
a. Policy split
b. Estate preservation rider
c. First-to-die term rider
d. Automatic increase in death benefit - Sold in the estate planning and business insurance market
Life and Annuity Product Features (LP-105-07) Chap 4
Substandards and Uninsurables for Survivorship
- Many survivorship sales are to older couples with substandard ratings
- This is OK since there are two lives – need one life to be healthy
- Increase in cost is much smaller than with a single life coverage
- Even if one life is uninsurable, may be offered with rate-up to age 90
- Important to distinguish between uninsurable lives and terminally ill
Life and Annuity Product Features (LP-105-07) Chap 4
Riders on Survivorship Products Usually Have an Explicit Charge Because
- Valuation issues arise if free term insurance is provided
- Market is sophisticated and knows that nothing is free
- Cost is relatively small and insureds are willing to pay for it
Life and Annuity Product Features (LP-105-07) Chap 4
Pricing Considerations for Survivorship
- Mortality
- Lapses –very high persistency
- Expenses – have to underwrite two lives
- Reinsurance – large face amounts and heavy reinsurance
- Cash value, reserves, and taxation
a. High cash value OK since lapses are low
b. High cash value will increase tax reserve and will increase profits. - Pricing Methodology – differences compared to single life products
a. Joint age calculation
b. Mortality contagion factor
c. Adjust retention limit
d. Reinsurance costs
e. Automatic increase in death benefit
Life and Annuity Product Features (LP-105-07) Chap 4
Mortality Assumption for Survivorship
- High face amounts will lead to strict underwriting
- Degree of underwriting concessions should be considered
- Joint accident risk and Broken heart syndrome
- All survivorship insurance is medically underwritten
- Socio-economic class of lives insured
- Impact of very low lapses on long-term mortality
- Married individuals should be lower than aggregate
- Higher exposure to female population
- More exposure to older ages
Life and Annuity Product Features (LP-105-07) Chap 4
Ways to Cover Substandard Mortality
FLAT Return
- Flat extra premiums
- Lien method
- Advance in age
- Table ratings
- Return of premiums
Life and Annuity Product Features (LP-105-07) Chap 5
Considerations When Determining Extra Premiums for Substandard Risks
- Number of and Definitions for Substandard Rating Classes
- Gross extra premium calculations
- Mortality – start with base mortality with no margins
- Subdivision by male/female and smoker/nonsmoker
- Subdivision by plan
- Expenses
- Not taken and lapse rates
- Extra cost of extended term and reduced paid up
- Premium paying period
- Supplementary benefits
- Reduction or removal of ratings
Life and Annuity Product Features (LP-105-07) Chap 5
Gross Extra Premium Calculations
LaTex needed.
Life and Annuity Product Features (LP-105-07) Chap 5
FPDA Surrender Charge Designs
- SC associated with each premium payment (% of premium)
- SC as a % of the sum of the premiums paid in past x months
- SC as a % of min(AV, last x years’ premiums)
Life and Annuity Product Features (LP-105-07) Chap 6
Penalty-free partial withdrawal provisions
- Enables the contract holder to surrender a portion of AV without SC
- Limits on the number of PW per year and the amount of PW
- Amount withdrawn may be limited to 50% of paid premiums
- Usually subject to a minimum withdrawal amount ($25-$100)
- Usually a minimum AV requirement after withdrawal
Life and Annuity Product Features (LP-105-07) Chap 6
Bonus Features for Deferred Annuities
- Annuitization bonuses – Often 2%-10% of AV
- Persistency bonuses
- Bonuses on large AVs
- New funds bonuses - additional 100 bps in first year after a deposit
Life and Annuity Product Features (LP-105-07) Chap 6
Pricing Considerations for Deferred Annuities
- Asset/Liability risk
- Interest spread and crediting strategy
- Withdrawal assumptions
- Mortality
- Commissions and expenses
- External factors
- Surplus strain (first year commission and reserve increase)
- Scenario/Sensitivity testing
- Profit Objectives
- Pricing horizons – 10 to 20 years is common
Life and Annuity Product Features (LP-105-07) Chap 6
Interest Spread For Deferred Annuities
- Credited Rate = Earned Rate - Spread
- New money or portfolio method
- Common to have target spread between 125-200 bps
- Useful to break spread into
a. Expenses
b. Losses on surrenders not offset by surrender charges
c, Product features
d. Risk charge
e. Profits
Life and Annuity Product Features (LP-105-07) Chap 6
Deferred Annuity Mortality, Commission, and Expenses
Mortality
- Not a significant factor in the pricing of DAs
- GMDB may cause mortality to be more important
- Select and ultimate mortality is not appropriate since there’s no underwriting
- Little industry guidance
Commissions and Expenses
- First year commission between 3% - 8% is common
- Trailer commissions are common
- Acquisition expenses are relatively low
- Maintenance expenses are relatively low
Life and Annuity Product Features (LP-105-07) Chap 6
Bailout Pricing
- Additional surplus strain due to statutory reserve requirements
- Value of option = cost of excess lapses + lost SCs + cost of artificially supporting a high credited rate
- Use dynamic interest scenario testing
- The cost will be the additional spread required to force median profit result to equal the profit under a deterministic profit test
- Approximate cost = avg lost SC * excess lapse rate * prob of trigger
- Total option cost = Cost of the option + cost of the additional required surplus
Life and Annuity Product Features (LP-105-07) Chap 6
Characteristics of Variable Deferred Annuities
- Funds can be deposited into separate accounts or general account
- Product Guarantees
a. Full AV will be paid at death (no SC)
b. Some guarantee that DB must be stipulated minimum
c. Guaranteed maximum expense charges - Product Charges
a. Front-end load
b. Rear-end load (SC)
c. Percentage of asset charge
d. Other Fees – may be assessed a periodic fixed fee
Life and Annuity Product Features (LP-105-07) Chap 7
Pricing Considerations for Variable Deferred Annuities
- Expense charges should be solved given desired profits
- Lapses – two measures: withdrawals and premium persistency
- Average size – measured in terms of premium
- Expenses
a. Similar to fixed deferred annuities
b. Higher administration expenses due to daily asset calc
Life and Annuity Product Features (LP-105-07) Chap 7
Pricing Considerations for Income Annuities
- Mortality
- Premium Taxes, Commissions, and Administrative Expenses
a. Assess all charges explicitly up front
b. Commission rates range 2%-4% of GP
c. Administrative charges expressed as per life or percent of benefits - Statutory Surplus Strain
a. Actuarial reserve established at issue will typically exceed the premium charged
Life and Annuity Product Features (LP-105-07) Chap 8
Mortality For Income Annuities
- Industry studies are available
- Use sex distinct mortality rates
- Mortality improvements should be priced into product to add conservatism
- Substandard mortality should be used for certain income annuities (structured settlements)
Life and Annuity Product Features (LP-105-07) Chap 8
Reasons for Lower Lapses on Post-Level Premium Term
- Policyholder complacency
- Automatic bank draft
- Meet short term needs while shopping around for new coverage
- Policyholder accepts increased premium
- Life events (divorce, marriage, birth of a child, unemployment, etc.)
Evolving Strategies…Post-Level Term Profitability
Structures for Post-Level Premium Term
- Original Approach - large premium jump followed by ART premium scale
- Simplified Re-Underwriting - separate classes that receive different ART premium scales
- Graded Approach - premiums step-up every five years
- Class-Continuation Approach - separate classes that receive different ART rates, but scales converge over time
Evolving Strategies…Post-Level Term Profitability
Post-Level Term - Original Approach Advantages and Disadvantages
Advantages of the traditional approach
- Reflects aging, wear-off of underwriting over the level term period
- Assigns an appropriate premium for the risk
- Increase premium will minimize reserves
Disadvantages of the traditional approach
- Large shock lapse at the end of the level term period
- Deteriorating mortality experience
- Claims volatility
- Reputation risk - some people see a 30x increase in premium
Evolving Strategies…Post-Level Term Profitability
Post-Level Term - Simplified Re-Underwriting Goals and Challenges
Goals of this approach
- Reduce the size of the shock lapse
- Provide smaller premium increases to the best risks
- Learn more about the health of insureds
Challenges with this approach
- Signal value - may alert policyholder of pending premium increase
- Difficulty in communications
Evolving Strategies…Post-Level Term Profitability
Post-Level Term - Graded Approach Goals and Challenges
Goals of this approach
- Reduce the size of the shock lapse
- Provide smaller premium increases upfront
- Eventually move everyone to aggregate rates
Challenges with this approach
- Best risks still have motivation to replace coverage
- Increase in premiums may not reflect risk of the remaining pool
- Future mortality experience is unknown
Evolving Strategies…Post-Level Term Profitability
Post-Level Term - Class-Continuation Goals and Challenges
Goals of this approach
- Reduce the size of the shock lapse
- Provide smaller premium increases to the best risk classes
- Use the results of previous underwriting
Challenges with this approach
- Not widely used in practice
- A preferred risk 10-15 years ago may have an impairment today
Evolving Strategies…Post-Level Term Profitability
Direct Writer Term Conversion Considerations
- Convert policies will have higher levels of mortality
- Restrictions
Policy duration limitations (e.g. up to the end of the term period)
Age limitations (e.g., up to age 70)
Cannot convert while on waiver - Data Issues
a. Might not be separately tracked in admin system
b. The number of converted policies is often understated
c. Limited experience data - Two methods to price for cost of conversion
a. Include excess mortality in permanent pricing
b. Include excess mortality in the term pricing
Term Conversions - A Reinsurer’s Perspective
Reinsurer Term Conversion Considerations
- Reinsurer can cover conversions in the term or permanent treaty
- YRT - separate or blended rates
- Coinsurance - need separate YRT rates
- Reinsurers have limited experience data
Term Conversions - A Reinsurer’s Perspective
Underwriting Types
- Fully underwritten
- Medical / Paramedical
- Nonmedical
- Simplified Issue
- Guaranteed Issue
- Guaranteed-to-Issue
Life Insurance Underwriting in the United States (LP-130-14)
Medical / Paramedical Exam
- Height and weight measurements
- Blood pressure readings
- Pulse rate
- Blood draw
- Urine specimen
- Series of medical questions
Life Insurance Underwriting in the United States (LP-130-14)
Guaranteed Issue Underwriting
- Few medical questions (or none)
- No medical / paramedical, blood or urine
- Cannot be turned down for coverage, with a few exceptions
- Small face amounts
- Return of premium upon death in first two years
Life Insurance Underwriting in the United States (LP-130-14)
Information in Full Policy Application
- Identifying information (Name, Address, Gender, DOB)
- Social security number
- Drivers license number
- Citizenship
- Occupation
- Financial information
- Smoking status
- Plan information
- Other coverage
- Whether the applicant has ever been denied coverage
- Owner
- Beneficiary
Life Insurance Underwriting in the United States (LP-130-14)
Developments in Life Underwriting
- Smoker/Nonsmoker
- Preferred underwriting
- Older age underwriting
- Predictive modeling
- Financial underwriting
- Policy Ownership
- Remote underwriting
- Outsourced underwriting
- Straight-through processing
Life Insurance Underwriting in the United States (LP-130-14)
Key Elements of Preferred Underwriting
- Alcohol and drug abuse
- Blood pressure
- Build
- Cholesterol
- Family history
- MVR
- Personal medical history
- Tobacco use
Life Insurance Underwriting in the United States (LP-130-14)
Knock-out vs. Credit/Debit Approach
- Knock-out approach - applicant needs to meet minimum criteria in a specified number of categories
- Credit/debit approach - credits and debits are compiled for the various categories and the total score determines the risk class
- Combination approaches
a. Start with credit/debit approach
b. Certain criteria will knock-out the applicant - Exceptions on a case by case basis
Life Insurance Underwriting in the United States (LP-130-14)
Special underwriting for Older Ages
- Cognitive testing
- Functional testing
- Changes to the traditional levels of underwriting acceptance
- Supplemental questionnaire
a. Living arrangements
b. Ability to perform Activities of Daily Living (ADL)
c. Social activities
d. Physical activities
e. Mental activities
f. Travel
Life Insurance Underwriting in the United States (LP-130-14)
Drivers of Change in Life Underwriting
- Speed - reduce time between policy application and policy issue
- Age-based underwriting - thresholds should vary with age
- Holistic approach - all information needs to be considered
- New work realities - remote underwriting will continue to grow
- Regulatory changes
- Accuracy - if there is a better way to assess risk in a cost effective manner, the industry will gravitate towards these methods
Life Insurance Underwriting in the United States (LP-130-14)
New Medical Markers
you will NOTT be a CCHHAMP without studying
- NT-proBNP - Congestive heart failure
- Oxidized LDL - Early detection of plaque and heart attack risk
- TNF (Tumor Necrosis Factor) alpha - Cancer
4, Troponin I and T - Determines if damage to heart - CBC (Complete Blood Count) - wider variation in widths implies higher mortality
- Cystatin C - Renal (kidney) function
- Hemoglobin - Anemia and other physiological diseases
- Hemoglobin A1c - Metabolism of glucose
- Apolipoprotein A and B - Lipid test
- Microalbumin - Early renal disease related to Diabetes
- Phospholipase A2 - Used to predict cardiac event or stroke
Life Insurance Underwriting in the United States (LP-130-14)
Protective Value Study
Costs
- Cost of the test
- Upfront training
- Time spent by the underwriter and the other personnel on an ongoing basis
- Cost of APS (attending physician statement)
Benefits
- Mortality savings due to this test
- Mortality savings due to needing to order an APS
- For replacement test, cost of the eliminated test
Life Insurance Underwriting in the United States (LP-130-14)
Applications of Automated Underwriting Alert Systems
- Alert underwriters to risk factors which are out of a normal range
- Advantages
a. Easier to implement and maintain
b. Allows underwriters to focus upon important information - Disadvantage
a. These systems cannot automatically make underwriting decisions
Automated Life Underwriting: Phase 2
Applications of Automated Underwriting Automated Simplified Issue and Non-medical
- Make underwriting decisions based on a predefined set of rules
- Common to limit face amount to 100K-250K
- Advantages
a. Challenging, but manageable to implement and maintain
b. Completes underwriting for many applicants
c. Very popular for certain markets - Disadvantage
a. Only available for smaller policies
Automated Life Underwriting: Phase 2
Applications of Automated Underwriting Automated Para-medical and Non-medical
- Translate underwriting manuals into programmed rules
- Advantages
a. Can replace underwriters for a subset of policies
b. Can drive ordering of requirements for cause
c. Can provide reasons why policies are referred to an underwriter - Disadvantages
a. Many applications still require underwriter review
b. Very costly to implement and maintain
Automated Life Underwriting: Phase 2
Automated Underwriting Operational Efficiency
Sources of cost savings:
- Reduction in time an underwriter spends on each case
- Reduction in call volume from producers to underwriters
- Reduction in clarifying emails between producer and underwriter
- Improved quality of application data (electronic format forces quality)
Sources of expenses inefficiencies
- Systems may order more attending physician statements (APS)
- High cost of implementing the automated underwriting system
- Reviewing more cases than intended
Automated Life Underwriting: Phase 2
Automated Underwriting Other Benefits and Challenges
- Many agents like the rapid response underwriting decisions
- More consistent than traditional underwriting
- Buyer’s remorse - increase in first year lapse rates
- Implementation takes more resources than expected
- Inexperienced underwriters can lose effective training grounds
Automated Life Underwriting: Phase 2
What are the legal rights of the policy owner in a mutual company?
- Favorable experience is used to increase surplus or pay dividends
- The policy owner owns a piece of the mutual insurance company
- The policy owner will get a fair and equitable share of the surplus
- Each line of business should be self-supporting, with little or no subsidization
- Each block of business should contribute to retained surplus
Policyholder Dividends (LP-110-07)
The Dividend Actuary
Who is the Dividend Actuary?
- Must be a member of the American Academy of Actuaries (AAA)
- Chief Actuary, senior corporate actuary, or individual life actuary
- The dividend actuary must know the company’s history
What are the Dividend Actuary’s responsibilities?
- Responsible for signing the Interrogatory for Individual Life to Schedule M of the statutory income statement
- Must recommend a dividend scale to the board of directors
- The dividend actuary will recommend to the board the aggregate amount of dividend to distribute
- Must distribute dividends in an equitable manner in proportion to the major source of earnings
- If the board chooses not to distribute dividends in a manner recommended by the Dividend Actuary and this action is not consistent with AAA standards of practice, it should be disclosed in the annual statement
Policyholder Dividends (LP-110-07)
Sources of Earnings That Drive a Dividend Scale
- Interest – largest component
- Mortality – assess mortality by block if credible
- Expenses – allocations should be equitable
- Persistency – ripple effects
- Other Items
a. Taxes
b. Mergers
c. Reinsurance
Policyholder Dividends (LP-110-07)
Sources of Earnings That Drive a Dividend Scale Interest Component
- Capital gains
a. Capital gains can be a substantial portion of investment income
b. Should realize capital gains in an equitable method - Investment crediting methods: Portfolio or IYM
a. Both methods are acceptable
b. Mutual companies tend to use the portfolio method - Policy loans – fixed or variable rate – direct or indirect recognition of loans
- Assets backing the dividend interest rate
a. Only actively invested assets should back the dividend interest rate
b. Assets such as occupied real estate should not impact the dividend scale
Policyholder Dividends (LP-110-07)
Methods Used When Changing Dividend Scales
- Pegging
a. Pay last year’s dividend if the new scale produces a lower dividend - Substitution
a. Replace current dividend formula, with the prior dividend formula
b. This can be very costly
c. Only use for new issues where dividends are small - Experience premium method
a. Just like pegging but carries the cost of pegging into future years
Policyholder Dividends (LP-110-07)
Adjusting Dividends for Experience
- Each block, if large enough, should reflect its own experience
- Small blocks should be averaged with the results of the entire company
- Mortality should be averaged over 3-5 years to add stability
- Expense allocation between blocks of business must be equitable
Policyholder Dividends (LP-110-07)
Retained Surplus
- What is reasonable retained surplus?
a. Companies try to target a broad range
b. Retained surplus needs to be enough to allow the business to grow - Entity surplus
a. Entity surplus = permanently retained surplus
b. Each group of policyholders must contribute to entity surplus
c. The larger the amount of risk OR the larger the amount of first year strain, the larger the expected contribution to entity surplus - Limitations on aggregate retained surplus
New York limits retained surplus to the greater of 10% of statutory reserves or the square root of the sum of the squares of 7% of statutory reserves and 35% of health premiums
Policyholder Dividends (LP-110-07)
Past Tax Law Changes Impacting Dividends
- 1959 Tax Act
a. Flaw was the “arithmetic menge formula”
b. Dividends were not deductible
c. Modco reinsurance to turn investment income into underwriting gains - Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)
a. Dividends were partially deductible
b. 77.5% for mutual companies and 85% for stock companies - Deficit Reduction Act of 1984 (DEFRA)
a. 100% deductibility of dividends
b. Moved from net level reserves to CRVM reserves
c. Dividends were changed from incurred basis to cash basis
d. Required to stop using modco reinsurance loop hole
e. Introduced the equity tax - Tax Reform Act of 1986 – changed tax rate and forgave modco offenders
- DAC Tax
Policyholder Dividends (LP-110-07)
Ways to Reflect the Equity Tax in the Dividend Scale
- Charge tax as it is incurred
- Best estimate average over a period of time – this creates stability
- Increase the annual contribution to surplus
- Use the target surplus formula and consider any excess tax as belonging to entity surplus
- Use the target surplus for each block of business (less diversification) and any excess tax belongs to retained surplus
- Charge the equity tax on the actual surplus of a given block
Policyholder Dividends (LP-110-07)
Ways to Reflect the DAC Tax
- As it is incurred for each block of business
a. Results in a large reduction in dividends followed by an increase in dividends
b. More complicated than the percent of premium method - As a flat percentage of premium charge
a. Can view the tax just like a premium tax
b. This method is the simplest way the handle the DAC tax
Policyholder Dividends (LP-110-07)
Stand-Alone LTCI Product Features
- Benefit triggers - 2 out of 6 ADLs or cognitive impairment
- Inflation protection of 5% per year is common
- Benefit designs
a. Daily, weekly, or monthly max
b. Expense reimbursement, indemnity, or disability-based
c. Maximum benefit periods/amounts (in year or dollars) - Elimination period
- Policies can cover one or multiple lives
- Premium structure
a. Regulations require that premiums do not increase after age 65
b. Level lifetime pay is most popular
c. Filed as guaranteed renewable
d. Discounts similar to individual life products
Quantification of Natural Hedge…Linked to LTC
LTCI/Life Rider Product Features
- Base life product can be UL, VUL, EIUL, whole life, etc.
- LTC is paid out via accelerated benefit (AB)
- LTC benefits reduce face amount
- Maximum amount paid will be a percentage of face amount
- Common to add on an additional extension of benefits (EOB) rider to extend benefits beyond what AB rider will pay
- Cross Funding payout structures - benefit payments are taken partially from the cash value and partially from the net amount of risk
Quantification of Natural Hedge…Linked to LTC
LTCI / Annuity Combo Product Features
- Base plan can be fixed annuity, variable annuity, or EIA
- Cross funding payout structures:
a. Tail design
b. Coinsurance Design
c. Pool Design - Inflation protection
- Waiting period will limit early duration claims
Quantification of Natural Hedge…Linked to LTC
LTCI Combination Product Considerations
- Tax considerations
a. 1035 exchanges are allowed
b. Charges to pay for LTCI benefits are not considered a distribution
c. Distributions from qualified riders attached to annuities are tax free - Target Market
a. Age 55+ (they better understand the need for LTC)
b. Affluent customers (single premium is common)
c. Exchange from existing life or annuity products - Distribution
a. Stand alone has many road blocks to sales
b. Producers want a simple product that is easy to explain
Quantification of Natural Hedge…Linked to LTC
Roadblocks to stand-alone LTCI sales
- Lack of education
- Underwriting
- High cost
- “Use it or lose it” benefit
Quantification of Natural Hedge…Linked to LTC
Key Risks for LTCI Products
- Persistency - lapse supported product
- Investment - low interest rates are a strain to pricing
- Morbidity - high incidence and low terminations are a strain to pricing
- Inflation - risk that LTC costs increase in the future
Quantification of Natural Hedge…Linked to LTC
Natural Hedge for Combination LTCI Products
- Persistency - lower lapses is a strain to LTCI but can increase profits for base products
- Investment - pass-through nature of investment risk for life and annuity products will make combination products “less risky”
- Mortality - high mortality is good for LTCI but bad for Life Product
- Incidence Rates - higher incidence rates first uses policyholder funds
Quantification of Natural Hedge…Linked to LTC
Universal Long-term Care Insurance Product Design
- Unbundled LTCI product
- Account value increases with premiums paid and decreases with expense charges and cost of insurance charges
- Interest is credited to the account value
- Flexible premiums
- Flexible benefits
- The policy lapses if the account value goes to zero
Deconstructing Long-Term Care Insurance (LP-131-15)
Universal Long-term Care Insurance Advantage and Disadvantages
Advantage of Universal LTC
- Lower interest rate risk
- Lower persistency and expense risk
- Current/Guaranteed charge structure similar to UL
- Premium and benefit flexibility
Challenges of Universal LTC
- Presence of account value will increase cost
- Insurer may still have to increase cost of insurance charges if claims experience is poor
- Insurance industry is slow to accept change
- Distribution - more complicated, need sales people to explain benefits
Deconstructing Long-Term Care Insurance (LP-131-15)
CI Product Design
- Sold with life insurance or on stand alone basis
- Level premiums and face amount
- Fully underwritten
- Full face amount paid if diagnosed with “covered condition”
- Must live 30 days past diagnosis to get benefit
- No payment for cancer claim if diagnosed within 90 days of issue
- Return of premium on death if diagnosis within 30 days of issue
- No cash values
Pricing Critical Illness Insurance in Canada (LP-126-13)
Versions of CI Product
- Basic –> Covers 3-4 conditions, such as heart attack, stroke, cancer, bypass surgery
- Enhanced –> Covers up to 20 conditions
- Enhanced + ROPX –> Covers up to 20 conditions + return of premium upon expiry
- Enhanced + ROPX + ROPS –> Covers up to 20 conditions + return of premium upon expiry + return of premium upon surrender
Pricing Critical Illness Insurance in Canada (LP-126-13)
Pricing Considerations of CI
- Main challenge – getting good CI incidence rates
- Expenses, compensation, taxes are similar to term life insurance
- Approaches to developing premium rates
a. Modeling approach
b. Competitive approach - Most business is reinsured
- Risk classes (gender, smoking status, band, and issue age)
- Sensitivity testing and scenario testing – similar to life pricing
- Limitations, definitions, exclusions
- Anti-selection
Pricing Critical Illness Insurance in Canada (LP-126-13)
Product Design of CI (LP-127-13)
Process to Develop CI Incidence Rates
- Obtain government data for various illnesses
- Adjust data to fit the covered conditions
- Adjust data for future trends
- Insured to population adjustment
- Split data into smoker vs. non-smoker incidence rates
- Use ratios to turn an aggregate table into a select and ultimate table
- Compare table to CI incidence rates in other countries to check for reasonableness
Pricing Critical Illness Insurance in Canada (LP-126-13)
Covered Conditions for CI
The Big 4
1. Cancer
2. Heart attack
3. Stroke
4. CABG
The next three
1. Multiple sclerosis
2. Kidney failure
3. Major organ transplant
Others
1. Cardiovascular (heart valve replacement, aortic surgery)
2. Degenerative (motor neuron disease, Parkinson’s, Alzheimer’s)
3. Brain (coma, benign, brain tumor)
4. Head (blindness, deafness, loss of speech)
5. Body (loss of limbs, paralysis, major burns, occupational HIV)
Product Design of Critical Illness in Canada (LP-127-13)
CI Exclusions
- Self inflicted
- Drinking and driving
- Drugs
- Criminal offense
- Two year misrepresentation
Product Design of Critical Illness in Canada (LP-127-13)
Features of CI
- Return of premium on death
- Return on premium on expiry
- Return of premiums on surrender – similar to a cash value
- Increasing or decreasing face amount
- Partial benefit paid for non-life threatening diseases
- Medical consulting services at time of claim
- Premiums are often fully guaranteed
These features can be standard or optional
Product Design of Critical Illness in Canada (LP-127-13)
Life Insurance Acceleration Riders
- Terminal illness rider - accelerate a portion of face amount when policyholder has a life expectancy of less than 12-24 months
- Chronic illness rider - accelerate a portion of face amount when policyholder is unable to perform two or more ADLs
- Critical illness rider - accelerate a portion of face amount when policyholder is subject to a critical illness
Life Insurance Acceleration Riders
Chronic Illness Rider Product Design
- Accelerated amount is considered a form of policy loan
- The amount accelerated will accrue with interest
- Policyholder will still pay premium on the full face
- Rider often has an explicit fee
Life Insurance Acceleration Riders
Chronic Illness Rider Risk Control
- Supplemental underwriting
- Limiting issue ages
- Cognitive testing
- Partial face is paid and interest charged on accelerated amount
- Annual limits on the accelerated amount
- Licensed health care practitioner certifies policyholder is eligible
- Reserving the right to pay for an independent examination
- Permanent loss of ADLs
- Limiting riders to certain table ratings
Life Insurance Acceleration Riders
Acceleration Rider Reinsurance
- Most insurance participate in terminate illness acceleration riders
- Reinsurer participation in other acceleration riders varies
- Reinsurers are more comfortable with permanent rather than term
- Reinsurer participation considerations:
a. Plan design
b. Risk controls
c. Discounting
d. Experience with living benefits - Reinsurer may want portion of rider fee
Life Insurance Acceleration Riders
EIA Product Design
- Single premiums are most common
- Index Account Value (IAV) available at the end of the Index Period
- GMAV designed to satisfy SNL
LaTex needed
- Account value will be the greater of the IAV and the GMAV
Equity Indexed Annuities (LP-102-07)
Components of the Indexed Based Interest Calculation
- Index – S&P 500 is most common
- Index Period – usually 7-10 years
- Index Growth %
- Participation Rate – applied to the Index Growth %
- Floor – usually 0%, which floors the IAV at the single premium
- Cap – will cap index-based interest
- Margin – method to decrease the index-based interest
Equity Indexed Annuities (LP-102-07)
Index Growth %
PAR
- Point-to-Point Index Growth %
a. Ignores interim ups and downs of the market
b. Considered more exact
c. Index Growth % = (Final Closing Level / Initial Closing Level) - 1 - Average Index Growth %
a. Averaging method will produce 55-60% of the PTP growth
LaTex Needed
- Ratcheting - locks in returns so that they cannot be lost by future poor index performance
Equity Indexed Annuities (LP-102-07)
Other EIA Design Features
- Annual Reset EIAs – indexed based interest components are guaranteed for shorter periods
- Flexible premiums – may have reduced GMAV
- Lower GMAV interest rates – SNL has changed, which allows for lower GMAV interest rates
- Index growth measurements
a. Binary Returns – Utilizes “either or logic”
b. High Water – uses the highest point to calculate the IAV - Customer Choice
a. Index Choice
b. Index Growth - averaging or point-to-point
c. Fixed Interest - receive a fixed rate for any contract year
d. Fund Transfer - can transfer funds between return methods - Inducements to purchase
- GMAV alternatives – can define GMAV as 100% of single premium that accumulates at a 2% rate
Equity Indexed Annuities (LP-102-07)
EIA Pricing and Design Considerations
- EIA Funding
Method #1 – Long term Guarantee
- Premium = GMAV Cost + PV Profit/Expenses + PV Index Budget
- Need to set aside premium to cover future costs
Method #2 – Short Term Guarantee
- Net Earned Rate = Pricing Spread + Hedging Costs
- GMAV funding can be included in a pricing spread
- Need to adjust IAV features to keep hedging costs down
- Funding Index-Based Interest
- Back indexed based interest with call options – OTC or Exchange
- Static hedging or dynamic hedging - Other EIA Pricing Considerations
Equity Indexed Annuities (LP-102-07)
Static and Dynamic Hedging
Static Hedging
- May require complex options (OTC market, interaction with banks)
- Buy-and-hold investment strategy , often using OTC options
- Most common static hedge involves a call spread option
- Funding ratio is generally < 100% due to lapse and death
Dynamic Hedging
- Can utilize actively traded options from an exchange
- Involves monitoring the delta and other “Greeks”
- If (delta * notional amount) is held, the IAV will be completely funded
- Requires periodic rebalancing
Equity Indexed Annuities (LP-102-07)
Other EIA Pricing Considerations
- Customer choice – need to monitor customer behavior
- Index return method – monthly averaging and point-to-point are most common
- Policy guarantees – one year guarantees are common because of low interest rates
- GMAV funding – key risks are default and interest rate risk
Equity Indexed Annuities (LP-102-07)
EIA Reserving Considerations
Actuarial Guideline 33 - covers CARVM, which makes the liability the maximum of the highest present value of cash flows
Actuarial Guideline 35: developed for EIAs as an interpretation of CARVM
Type 1 Method (book value based)
- Enhanced Discounted Intrinsic Method (EDIM)
- Book value of hedging instruments is basis for the reserve
- Hedged as required criteria must be met
Type 2 Methods
- CARVM with updated market values method (CARVM-UMV)
- Market value reserve method (MVRM)
- Type 2 methods do not require hedged as required criteria
Equity Indexed Annuities (LP-102-07)
Equity Indexed Annuities SNL Implications
- Old Law
a. CV must be LaTex needed
b. Flexible premium requires 65% of first year premium and 87.5% of renewal premiums - Temporary Law
a. Temporarily changed the 3% to 1.5% - New Law
a. SPDAs and FPDAs
b. Accumulation rate based on the 5-year CMT less 125 basis points, subject to 1% min and 3% max
c. Reset provision
d. Additional 100 basis point reduction allowed for EIAs
Equity Indexed Annuities (LP-102-07)
Requirements of EIA Investment Plan and Hedging Strategy
- Name, qualifications, and experience of investment or ALM manager
- Types of assets planned to back contracts
- How much premium will be earmarked for derivatives investing
- Statutory authority that permits use of derivatives
- List of possible counter-parties
- Description of due diligence performed
- Descriptions of risk management with respect to hedging risks
- Availability of hedging instruments
- How accounting of derivatives can distort income statement or balance sheet
- How assets funding EIAs will be separated from non-indexed contracts
- Plans for being hedged as required, if applicable
Equity Indexed Annuities (LP-102-07)
Factors Which Influence Starting of Withdrawals for Variable Annuities
- Source of funding - after age 70 qualified annuities take more withdrawals
- Size of contract
- Deferral incentives
- Duration
- Distribution channel
Variable Annuity Guaranteed Living Benefits Utilization
Variable Annuity Withdrawals Other Considerations
- Majority of owners take withdrawals through systematic withdrawal plans (SWPs)
- Once owners start withdrawals, they tend to continue
- Older owners are more likely to take withdrawals through SWP
- SWP owners tend to stay within the maximum withdrawal amount
- Younger owners are more likely to take out more than the max withdrawal
Variable Annuity Guaranteed Living Benefits Utilization
Variable Annuity Surrenders Considerations
- If a policyholder is going to use the rider, surrender rates are low
- If older than 65 and not taking withdrawals, surrender rate increases
- U-shaped relationship when compared to percent of benefit maximum
- In-the-money will decrease surrenders
- Withdrawal activity can be a leading indicator of surrender activity
Variable Annuity Guaranteed Living Benefits Utilization
Variable Annuity With GLWB Current Market Stats
- Average age was 63
- Average premium was 129k
- Average contract value was $135k
- At the beginning of 2013, 79% of contracts issued before 2013 were in-the-money
- 23% of contracts had at least some withdrawal activity during 2013
- Median amount withdrawn was $5,800 or 6.4% of contract value
- Little additional premiums beyond the first year
- Surrender rates were 3%
- Average GLB rider cost was 320 bps
Variable Annuity Guaranteed Living Benefits Utilization
Variable Annuity With GMWB Current Market Stats
- 48% of owners are 70 or older
- At the beginning of 2013, 53% of contracts issued before 2013 were in-the-money
- 47% of contracts had at least some withdrawal activity during 2013
- Median amount withdrawn was $6,000
- Little additional premiums beyond the first year
- Surrender rates were 8.2%
- Average GMWB rider cost was 213 bps
Variable Annuity Guaranteed Living Benefits Utilization
Variable Annuity With GMIB Current Market Stats
- Average age is 63
- At the beginning of 2013, 83% of contracts issued before 2013 were in-the-money
- Annuitization rate was for only 0.3%
- 27% of contracts had at least some withdrawal activity during 2013
- Median amount withdrawn was $6,000
- Little additional premiums beyond the first year
- Surrender rates were 3.9%
Variable Annuity Guaranteed Living Benefits Utilization
Variable Annuity With GMAB Current Market Stats
- Average age is 59
- At the beginning of 2013, 18% of contracts issued before 2013 were in-the-money
- 17% of contracts had at least some withdrawal activity during 2013
- Median amount withdrawn was $7,000
- Surrender rates were 10.9%
- Average rider cost was 222 bps
Variable Annuity Guaranteed Living Benefits Utilization
