Ch 24: Pricing and financing strategies Flashcards

1
Q

What is the difference between the cost and the price of a set of benefits?

A

The cost of benefits is the amount that should theoretically be charges for them.

The price of benefits is the amount that can actually be charged under a particular set of market conditions. It may be more or less than the cost.

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2
Q

Formula for the value of premiums to charge

A

Value of premiums = value of benefits + value of expenses + contribution to profit

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3
Q

List other factors to consider when determining the cost of benefits

A
  1. tax
  2. commission
  3. the cost of any capital supporting the product
  4. margins for contingencies
  5. the cost of any options and guarantees
  6. the provisioning basis
  7. experience rating
  8. investment income
  9. reinsurance
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4
Q

Give 5 reasons why the price charged might differ from the cost for an insurance contract

A
  1. The provider’s distribution system for the product enable it to sell above the market price, or to take advantage of economies of scale and reduce the premiums charged.
  2. The provider might have a captive market, such as an affinity group, that is not price sensitive.
  3. A cheaper price might also be the result of the provider taking a lower or no contribution to expense overheads and profit.
  4. Loss leader: a cheap product may attract customers to other, more profitable products of the company.
  5. Underwriting cycle: there may only be a limited number of providers in the market and so higher premiums can be charged. Alternatively if there are lots of providers in the market, premiums will fall.
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5
Q

List 6 ways of financing pension scheme benefits

A
  1. Pay as you go
  2. Smoothed pay as you go
  3. Terminal funding
  4. Just in time funding
  5. Regular contributions
  6. Lump sum in advance

All financing strategies are influenced by RISK TOLERANCE and TAX TREATMENT.

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6
Q

Pay-as-you-go

A

Benefits are met out of current revenue and there is no funding

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7
Q

Smoothed pay-as-you-go

A

The same as pay as you go but with a small fund to smooth effects of timing differences between contributions and benefits, short term business cycles and long term population change.

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8
Q

Terminal funding

A

A lump sum is set aside to cover all the expected benefit costs when the first tranche of business becomes payable.

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9
Q

Just-in-time funding

A

Funds are set aside only in response to an external event such as the sale of an employer

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10
Q

Regular contributions

A

Funds are gradually built up between promise and first benefit payment

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11
Q

Lump sum in advance

A

A lump sum is set aside to cover the expected benefit cost when the benefit is promised

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12
Q

Give three reasons why the actual contribution rate might differ from the calculated theoretical cost of the future benefits in a pension scheme

A
  1. The scheme may be in a deficit and the contribution rate may have to be increased to eliminate the deficit. Alternatively, the scheme may be in surplus and the contribution rate may be reduced to eliminate the surplus.
  2. The sponsor may want to alter the pace of funding by paying a higher or lower contribution in any year.
  3. There might be legislative restrictions (upper and lower) on contributions.
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13
Q

3 Factors influencing the price

A
  • distribution channels employed
  • level of competition in the market
  • premium frequency

Think about the things to consider when a model spits out a premium:

  • distribution channel
  • product design
  • size of market (competition)
  • profit requirement
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14
Q

2 ways of viewing a product price

A
  • Factor a profit criterion into the pricing process, and thus calculate the resultant premium. Test whether the premium is acceptable in the market.
  • Input the desired premium into the pricing model and calculate the resultant profit. Test whether this is acceptable to the company.
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15
Q

4 Examples of distributions systems

A
  • independent intermediaries
  • tied agents
  • own sales force
  • direct marketing
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16
Q

Independent intermediaries

A

Individuals who select products for their clients from all or most of those available on the market.

17
Q

Tied agents

A

Offer the products of one provider or a small number of providers.

18
Q

“own sales force”

A

Usually employed by a particular provider to sell its products directly to the public.

19
Q

Direct marketing

A

Press advertising, over the telephone, internet or mailshots.

20
Q

3 Reasons for changes to the pace of funding

A
  • changes in the fortunes of the sponsor
  • the opportunity cost of the contributions and alternative investment opportunities
  • changes in view over the degree of caution / optimism required
21
Q

5 advantages of pay-as-you-go

A
  • allows benefits to be introduced at a worthwhile level in the early years as there is no need to wait for a fund to accumulate
  • involves lower transaction costs (there is no funding)
  • prevents funds from being tied up in the scheme
  • for State-operated schemes it can increase solidarity within the community
  • makes it easier to organise payment according to need with contributions according to ability to pay