T_Product Design and Pricing Flashcards
Factors in Product Design (1)
Profitability- Premiums should cover claims, expenses and provide a profit margin.
Marketability- Innovation, charging structure, premium rate guarantees.
Competitiveness- Should not depart too much from competitors, but may try to innovate.
Financing Requirement- Depends on benefit and charges design, influenced by availability of capital resources.
Risk Characteristics- Depends on company’s appetite to accept or reinsure risk.
Onerousness of Options and Guarantees- E.g. level of surrender values under non-linked contracts.
Sensitivity of Profit- E.g. may be less sensitive if charges can vary as experience changes.
Factors in Product Design (2)
Extent of Cross-Subsidies- E.g. between large and small contracts, trade-off with simplicity of design.
Administration Systems- May constrain benefit and charging structure.
Consistency with Other Products- Easier to implement if similar to existing products, reduces risk of policyholders lapsing on old products.
Regulatory Requirements- Must adhere to regulatory requirement and keep abreast of potential changes.
Some factors are not independent and compromises are needed, e.g. between competitiveness and profitability.
Demographic Assumptions
Mortality
- Should reflect expected experience of lives who will purchase the product
- Typically use standard table, adjust for own experience.
- Data should be ideally of a credible volume and divided into homogeneous groups.
- Can also use similar product data, industry data, national statistics or reinsurer data.
- Consider if experience for lives being priced may differ e.g. due to changes in u/w.
- Consider expected changes in rates over time e.g. longevity improvement for annuities.
- Need to exercise further caution if premiums are guaranteed.
Morbidity
- For income protection, model benefits using multi-state models.
- Transition intensities should be calculated for homogeneous groups.
Critical Illness- Separate rates may be needed, theoretically, for each covered condition.
Mortality assumptions
- Should reflect expected experience of lives who will purchase the product.
- Typically use standard table, adjust for own experience.
- Data should be ideally of a credible volume and divided into homogeneous groups.
- Can also use similar product data, industry data, national statistics or reinsurer data.
- Consider if experience for lives being priced may differ e.g. due to changes in u/w.
- Consider expected changes in rates over time e.g. longevity improvement for annuities.
- Need to exercise further caution if premiums are guaranteed.
Morbidity assumptions
- For income protection, model benefits using multi-state models.
- Transition intensities should be calculated for homogeneous groups.
Critical Illness- Separate rates may be needed, theoretically, for each covered condition.
Investment Return assumptions
- Intended investment mix and current & expected returns on those assets.
- Importance depends on extent of reserves built up in the policy and guarantees given.
- Extent of guarantees also affect asset mix and hence expected return.
- Consider extent of reinvestment risk.
Expenses and Commission assumptions
- Should reflect expected amount of expenses to administer the policy.
- Analyse recent experience of expenses for type of business being considered.
- Source of risk related to how company allows for fixed expenses, i.e. how to allocate expenses that do not vary by size of the policy.
- Commission assumption typically based on commission rates paid in the market.
Inflation of Expenses assumptions
- Consider current and expected future rates of inflation for prices and earnings.
- Difference in return of government index-linked and fixed-interest securities, if available.
- Recent experience of the company or industry.
Withdrawals assumptions
- Should reflected expected experience on products being priced.
- Based on company’s recent experience, or experience under similar contracts.
- Could also use industry data.
- Data should be adjusted for special factors e.g. an adverse economic situation may have led to poor experience that may not be expected in the future.
- Consider differences in the data from the contracts being priced, e.g. different benefits, target market or distribution channel.
Profit Requirements - assumptions
- Investors in a life company require a return, relative to the risk the insurer takes on.
- Investors will require a risk premium above the risk-free rate for the excess risk taken on.
- CAPM is one method to calculate the risk premium.
- CAPM is based on the theory that the return on a well diversified portfolio above the risk free rate represents the average risk premium over a period of time.
- The risk premium for a particular share is then in proportion to its Beta.
- Not all products are equally risky, insurers should consider themselves investors when considering the risk levels, and allowance thereof, of different products.
