AFE 1 Flashcards
(238 cards)
1
Q
Tontines
A
any arrangement under which amounts are paid into a fund by participant who receive payments from the fund only for as long as they live, with a portion of the forfeited fund of deceased participants being used to augment payment to survivors. When participants died, their annuity payment ceased. Portions of these former payments are then allocated among the survivors in what today are called benefits of survivorship.
2
Q
Mortality risk
A
Possibility that one’s death creates undesirable financial consequences for others; covered by life insurance (or life assurance)
3
Q
Longevity risk
A
possibility of outliving one’s financial resources; covered by endowments, annuities and pensions, and
4
Q
Morbidity risk
A
possibility that injury, illness, or incapacity creates unacceptable financial consequences; covered by health insurance, disability income insurance, and long term care insurance.
5
Q
Economy of scale
A
marginal costs savings that exist when a firm’s output increases at a rate faster than attendant (associated) increases in production costs, holding product mix constant, i.e. average cost decrease.
6
Q
Human capital
A
is the productive capacity within each person and is considered to be the driving force in economic growth. Investments are made within oneself with an expectation of future benefit. Present value of an individual’s future earnings.
7
Q
Human life value
A
is a measure of the future earnings or value of services of an individual – that is, the capitalized value of an individual’s future earnings less self-maintenance cost such as food, clothing, and shelter. A person may have more than one HLV i.e. viewpoint of an organization for employee HLV is based on the value added to the enterprise through his services to the firm.
8
Q
Endowments
A
are life insurance policies that pay a stated sum if the insured dies before a prescribed time period and usually the same sum if the insured survives the time period. Endowments pay out a lump sum if the insured after a specific term (on its maturity) or on death
9
Q
Life insurance Policies that pay a prescribed death benefit if the insured dies during the policy term are commonly labeled
A
variously called the face amount, sum assured or death benefit amount on the death of the insured (applicant).
10
Q
Bundle policies
A
the policyholder is not informed as to how the premium is allocated to cover the insurer’s operational expense, taxes, and contingencies; to pay for the pure insurance component; to build cash values; or to support the scale of dividends for participating policies.
11
Q
unbundled policies
A
contemporary policies that discloses to the policyholder the portion of his/her premium that are allocated to pay for the costs of the internal insurance; to build cash value; and to cover the insurer’s expenses, taxes, profits, and contingencies.
12
Q
renewable
A
Term policies with level death benefits and increasing premiums are commonly referred to as renewable, granting the policyowner the right to continue the life insurance policy for one or more specified periods merely by paying the billed premium.
13
Q
Net amount at risk (NAR)
A
Difference between the policy death benefit and the cash value or policy reserve.
14
Q
Universal life insurance (UL)
A
are characterized by flexible premium payments and adjustable death benefits whose cash value and coverage periods depend on the premiums paid into them. Usually Nonparticipating but they routinely share in the insurer’s operational results via nonguaranteed policy elements other than dividends. All cash value policies are a combination of term insurance and a savings element.
15
Q
Whole life insurance (WL)
A
typically requires the payment of fixed premiums and promises to pay a fixed death benefit whenever the insured dies and therefore, is life insurance intended to remain in effect for the insured’s entire lifetime. Often participating, but nonpar policies also exist. Unlike UL policies, premiums for WL policies (1) are directly related to the amount of insurance purchased, (2) must be paid when due or the policy will terminate, and (3) are calculated to ensure that the policy will remain in effect for the entire lifetime of the insured, which often is assumed to be age 100 or 121.
16
Q
Ordinary life (aka level premium whole life)
A
uniform premiums are assumed to be paid over the entirety of the insured’s lifetime. Lowest premium and cash value.
17
Q
Paid up
A
meaning that no further premiums need be paid and the contract is guaranteed to remain in effect for the insured’s entire lifetime. At this point, the premiums paid into the policy equal the cash value (face value equals the cash value). This means that the policy has been paid for and the insured owns the benefits until death when they are paid to the beneficiary.
18
Q
single premium whole life
A
the WL policy with the highest premium (and highest cash value, which only a single (large) premium payment is made at policy inception.
19
Q
Endowment insurance
A
life insurance that makes two mutually exclusive promises: to pay a stated benefit if the insured dies during the policy term or if the insured survives the stated policy term. IF paid on survival, the policy was said to endow. Endowments are life insurance policies that pay a stated sum if the insured dies before a prescribed time period and usually the same sum if the insured survives the time period.
20
Q
Annuity certain
A
makes payments for a set period of time without reference to whether the annuitant is alive.
21
Q
Three broad categories of potential economic losses associated with the risk are
A
a. Medical expense when injured or sick.
b. Incur expense to provide long term care if mental or physical illness, injury, or old-age prevents them from engaging in the activities of daily leaving
c. Poor health or incapacity which means reeducation or even elimination of wages.
Medical expense insurance, long term care (LTC) insurance, and disability income insurance policies are designed to meet loss exposures, respectively, to the above health risk.
22
Q
guaranteed renewable health insurance policies
A
the insured has the contractual right to continue the policy by the timely payment of premiums, usually a specified age, but the magnitude of future premiums usually is not guaranteed.
23
Q
Homogeneous Exposure Units – or identically distributed
A
Random variables whose probability distributions prescribe the same probability to each potential occurrence, which renders the distribution expected (IID –independent and identically distributed) values and variance equal. This condition is important because it allows insurers to charge each independent and identically distributed (IID) insured the same premium.
24
Q
Pricing elements
A
(Mortality, investment, expenses and taxes, persistency). Gross premium for many bundled par cash value polices are calculated using the maximum mortality and loading charges and minimum guaranteed interest rates, resulting in comparatively high, conservatively set premiums. Participating life insurance has been associated closely with mutual (policyholder-owner) insurance companies and nonpar has been associated more closely with stock (stockholder-owner) insurers.
25
Experience factors
Experience factors are the actual results experienced by an insurer as to mortality, investment returns, expenses, taxes, and persistency. Experience factors allow actuaries to derive actual mortality charges to be levied against policies, interest rates to be credited to their cash values, and loading charges to be levied, irrespective of whether they are stated this way or disclosed.
26
Persistency
is the percentage of life insurance policies not terminated by lapse or surrender. Persistency is not a policy element as are mortality charges, interest credits, and loading charges, but is important as assets that insurers accumulate from block of policies do not precisely equal the liabilities that arise from those polices.
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lapse
is the termination of a life insurance policy and the insurer’s obligations after expiration of its grace period for failure to pay a premium necessary to maintain it in full effect.
28
asset share
the conceptual segmentation of individual policies of an insurer’s general account investment accumulated on behalf of a group of policies.
29
Surplus strain
Condition that occurs when a life insurance policy is surrendered and its assets share is less that it cash surrender value.
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Surrender gain
Condition that occurs when a life insurance policy is surrendered and its assets share is greater that it cash surrender value.
31
Life insurance products are classified into one of four categories
ordinary, industrial, group, or credit.
32
Renewability
Level death benefits and premiums although level for each interim period, increase with each renewal and is based on the insured’s attained age at renewal time. Scale of guaranteed future premium rates is contained in the contract, although some policies have indeterminate premiums that allow the company to charge rates lower than those guaranteed in the policy.
33
Reentry
Provision within some term life policies that allows for the payment of premiums lower than guaranteed renewal premiums and sometimes lower than indeterminate renew premiums if the insured can demonstrate that he or she meets continuing insurability criteria.
34
Select mortality tables
show probabilities of death by age, sex, and duration of insurance for newly insured lives only. These insureds exhibit lower death rates than other of the same age and sex, since they must have been in good health and otherwise insurable to qualify initially. The select period or benefit of selection usually last from 5 to 25 years. Insurer can demonstrate continued insurability, therefore enjoy lower premium rates based on select mortality for their attained age.
35
Ultimate mortality tables
show probabilities of death by age and sex of insureds after the select period. The benefit of selection has faded from the mortality experience for the ultimate group. Insurer can NOT demonstrate continued insurability, therefore, ultimate rates are charged thereafter.
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Aggregate mortality tables
show probabilities of death by age and sex of insureds by combining both select and ultimate mortality.
37
Policies that Provide a Level Death Benefit
Term policies with increasing premiums are commonly referred to as contracts that are renewable, a term that is synonymous with increasing premium. Other examples include YRT, ART. Whatever the renewal period, premiums increase at each renewal, more or less tracking the increase in mortality rates for the insured’s attained age or an average of future such rates over the next term period. Riders are available to supplement a permanent policy.
38
Policies that Provide a Non-Level Death Benefit
policies whose face amount decreases or increase with time. Decreasing term polices are commonly used to pay off a loan balance on the death of the debtor/insured in connection with a mortgage loan or a business or personal loan:
39
Cost of living adjustment (COLA)
rider that provides increasing term insurance that provides automatic increase in a policy’s death benefit in accordance with increases in inflation, as measured by a national cost-of-living index, such as the Consumer Price Index (CPI)
40
Return on premium (ROP) term policy
sold as a rider. Unlike the return of premium death benefit, this policy promises to pay an amount equal to the sum of premiums paid for the policy if the insured survives to a certain period, which may be from 10 to 30 years, depending on the insured’s age and insurer’s requirements. One insurer’s regular 30 yr level premium term policy for $1 mil carries an annual premium of $1,178. Its $1 mil ROP policy issued on the same basis carries an annual premium of $2,570. The annual premium difference of $1,392 effectively provides for the cash value buildup; i.e, the “return of premium’ feature, which would equal $77,100 (2,570 x 30) payable in 30 years if the insured survives to that point. If the insured dies before 30 years, the $1 mil face amount is paid.
41
Contributory plan
employer and employees make contributions toward the plan’s premiums
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Noncontributory plan
only employer makes contribution toward plan costs
43
Probationary period
(waiting period) is the period of time (usually one to six months) after being hired that a new employee becomes eligible to participate in an employee benefit plan. After completion of probationary period, under a noncontributory plan, the employee automatically is coved.
44
eligibility period
b. Under a contributory plan an employee is given a period of time, known as the Eligibility period: under a contributory employee benefit plan, the period of time that an employee is given during which he or she is entitled to apply for insurance without submitting evidence of insurability.
45
Front-end load
some unbundled polices also feature an explicit front-end load which is deducted from premium payments for expenses, taxes, contingencies, and sometimes profit.
46
Universal life policies typically offer two optional death benefit patterns:
i. Option A: the death benefit remains level. The net amount at risk (NAR) decreases as the account value increases (and vice versa)
ii. Option B: Provides a level NAR, so that the death benefit equals what is sometimes called the face amount in UL parlance (which is the same as the death benefit in Option A) plus an additional death benefit equal to the account value.
47
SEC
Securities and Exchange Commision
48
FINRA
Financial Industry Regulatory Authority
49
guaranteed minimum death benefit (GMDB)
Offered by most VUL policies that feature or rider for an additional premium, which guarantees that a specified minimum death benefit will be paid irrespective of whether the policy account value is positive, provided benchmark premiums have been paid.
50
Equity-indexed universal life (EIUL)
aka indexed UL. is a comparatively recent UL variation with the same operational characteristics and platform as generic UL products but with an interest crediting rate being either that which the insurer uses for its general account-based products or that determined by reference to one or more equity indexes, such as the S&P 500 index. EIUL differs from generic UL as well as VUL in this interest crediting mechanism.
51
Operational Details of Equity-Indexed Universal Life Insurance
as with other non-variable life products, the EIUL account value is backed by the insurer’s general account assets, but it is divided into two or more policy accounts: a fixed account and one or more index accounts. The placeholder decides on the funds to be allocated to each account.
The fixed account crediting rate is typically the same as that found with the insurer’s other UL policies, bring influenced by the investment returns in its general account.
52
Index account
is that portion of the EIUL cash (account)value for which the crediting rate is determined by changes in an equity index, subject to a guaranteed minimum crediting rate, called the growth floor, and a maximum crediting rate, called the growth cap. Index performance rate x participation rate = index crediting rate (taking into account growth caps)
53
Index performance rate
the change in the index’s market value. Dividend income ordinarily is excluded in deriving this rate. Each transfer of funds into the index account creates a new segment of a specific duration, called the segment term. Upon maturity of each segment term, the index crediting rate calculation is restarted. The effect of this reset is to carry forward gains and avoid carrying forward loses, as the zero percent floor insulates the account value.
54
Participation rate
Under an equity indexed universal life policy or annuity, the proportion of the index performance rate that is counted in deriving the growth rate.
55
Importance of Cash Values
All whole life policies involve prefunding of future mortality costs. The degree of prefunding is a function of the premium payment pattern and duration. Because of prefunding, all WL policies are required to have cash values, and the cash value must build to the policy face amount by the terminal age of the underlying mortality table.
56
Net cash surrender value
its gross cash value less surrender charges (or back-end loading) and the value of any outstanding loans plus the value of any dividends on deposit and the cash value of any paid up additions.
57
Dividend options
Dividends may be applied or taken I one or more several ways. Policyowner elects the desired option:
a. Cash – pay cash each year to policyowner
b. Apply toward Premium payment
c. Purchase Paid up addition insurance-(aka paid up additions PUAs) the dividend is applied as a net single premium at the insured’s attained age to purchase as much paid up WL insurance as it will paid up.
d. Accumulate at interest – Dividends held by the insurer to accumulate at interest under the contract.
e. Purchase one year term
58
Pre-need funeral insurance
WL that pays death proceeds specified by the details of the goods and services to be delivered by the funeral provider. Whole life insurance benefits earmarked to prefund future funeral expenses.
59
Grace Period Provision
requires the insurer to maintain the policy in force and to accept premium payments for a certain period after the premium due date or if the policy has insufficient account value to permit it to continue in force. State requires a minimum grace period of 30-31 days. UL policies typically offer 61 days. During this period, insurer is required to accept payment and not require evidence of insurability as a condition of premium acceptance. Insurer is required to: 1. Accept payment even though is late and 2. May not require evidence of insurability.
60
Reinstatement clause
gives the policyholder the right to reinstate a lapsed policy under certain conditions. The two most important conditions are 1. Furnishing evidence of insurability and 2. Paying past due premiums or charges.
61
Misstatement of age or sex provision
required life insurance policy provision stipulating that, if the insurer’s age is found to have been misstated, adjustment will be made in policy values to reflect the true age. Incontestable clause does not apply to age or sex misstatement.
62
Revocable designation
one that may be changed by the policy owner without the beneficiary’s consent. An irrevocable designation is one that can be changed only with the beneficiary’s express consent.
63
Simultaneous death of insured and beneficiary
If the insured and the beneficiary die in the same accident and no evidence shows who died first, the proceeds of the policy shall be distributed as if the insured had survived the beneficiary. Thus proceeds are paid to the estate of the insured. If the proceeds are payable in a lump sum and no contingent beneficiary is named, no matter who is determined to have survived, the proceeds will be paid into the state – of either the insured or the beneficiary.
64
Policy loan provision
Cash value life insurance policy provision requiring the insurer to make requested loans to policyowner’s on the sole security of the policy’s cash value, subject to certain limitation. Key elements are:
1. The insurer will lend to the policyowner an amount not to exceed the net policy cash surrender value less interest to the next policy anniversary (and, for variable policies, a further reduction typically of 10%) and, with UL policies, a deduction for charges for the balance of the policy year.
2. Loan interest is payable annually at a rate specified in the policy
3. Any due and unpaid interest will be paid automatically by a further policy loan.
4. If total indebtedness equals or exceeds the cash surrender value, the policy will terminate, subject to the grace period
5. The policyowner may repay the loan in whole or in part at any time, and
6. If the policy terminates by surrender or death, the indebtedness will be deducted from policy proceeds.
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Automatic Premium Loans (APL)
)– a provision within the policy. If a premium is unpaid at the end of the grace period and if the policy has sufficient net surrender value, the amount of the premium due will be advanced automatically as a loan against the policy. UL polices, by their nature, have no need for APL provision.
66
Dividend Options
dividends may be 1.received in cash, 2.applied toward payment of the premium, 3.used to purchase paid up additions, 4.left with the company to accumulate at interest, and 5.used to purchase on-year term insurance.
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Living Benefit Riders
Promise to pay some or all of a policy’s face amount prior to the insured’s death if the insured suffers some specified adverse health condition. Also sometimes called accelerated benefit rider.
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Annuitization
conversion of a savings annuity to a payout annuity that liquidates principal over the course of an annuitant’s life or a stated period
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Fixed annuities (FAs)
credit investment returns to policies based indirectly on the performance of the insurer’s general account investment or directly in changes in a specified inflation or equity index
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Variable annuities (VAs)
depend directly on the performance of separate account funds specified by the owner
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Annuities may be purchased with a single lump-sum premium or flexible. The three basic purchase structure are:
single premium immediate annuity (SPIA), the single premium deferred annuity (SPDA), and the flexible premium deferred annuity (FPDA).
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The determination and commencement of benefits are simultaneous with SPIA, SPDA and FPDA. The amount of the annuitized benefit payment depends on the insurer’s expected mortality and interest earnings at the time of annuitization. Insurers have also begun to offer longevity annuities (deferred income annuities)
which are single premium deferred annuities (SPDA) that guarantee future income payments based on current rates, the income typically commencing a decade or more into the future and typically providing no death benefit or surrender value during the accumulation period.
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SPIA
begin to pay benefits one period, typically a month, after a simple premium is paid. They are in liquidation at the beginning of the contract.
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SPDA and FPDA
are both deferred annuities, the difference being the former is purchased by a single premium and the latter with flexible periodic premiums. Both serve as savings accumulation vehicles until the owner elects to annuitize, thus converting to an immediate annuity.
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Differed annuities have two periods
The accumulation period (premiums paid and cash value accumulate) and the liquidation period (annuity payments made). The annuitant is said to enter onto the annuity at the time the accumulation period ends and liquidation via an income option begins.
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General Account Fixed Annuity
FPDA and SPDA contracts typically guarantee a minimum interest rate. Most insurer use a back-end load or surrender charge on policy termination. Most contracts permit a free withdrawal corridor, meaning that no surrender charge will be assessed on limited cash value withdrawals, such as those of less than 10% of the cash value. anticipated
77
Equity-Indexed Annuities (EIA)
is a fixed annuity contract whose interest crediting mechanism is either a guaranteed minimum rate or a rate derived directly from an external index, such as the standard & Poor’s 500 index in the US. The minimum rate is 0-2%. It contains elements of both fixed and variable annuities. The minimum guaranteed interest rate provides a downside guarantee. Like Vas, they offer the potential for stock-market-like gains by tying the current crediting rate to equity indices, thus providing upside participation. Most EIA are issued as SPDA, although flexible premiums varieties are emerging. EIA function similarly to equity-indexed universal life insurance (CH3). The upside participation generally is stated as a percentage of the increase in the index from issue to maturity.
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Index-linked interest credits
are calculated over the index term (5-10 yrs) and added to the policy’s account value based on the indexing method, performance of the index, the participation rate, any cap, and the guarantee.
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Substandard Mortality Annuities
most life annuities are issued without underwriting or any evaluation of the annuitant’s health. However, two classes of annuities are available for annuitants whose mortality experience is expected to be below average, which are SSA and Substandard Annuities.
80
Structured Settlement Annuities (SSA)
is a SPIA contract issued by a life insurer whereby the plaintiff (the injured party) receives periodic payments via a life annuity paid by the defended (or the liability insurer) in a personal injury lawsuit instead of the more common lump sum payment.
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Retirement Plans
This section identifies group products provided by employers and retirement plan trust that protect a retirement plan sponsor from the financial risk of plan participants living longer than average lives.
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Qualified plans
are retirement plans that satisfy the requirements of the federal employee retirement income security act (ERISA) and the federal internal revenue code (IRC).
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Qualified pension plans come in two generic
Defined benefit plans specify the benefits required to be provided participant employee at retirement and Define contribution plans specify the contributions that sponsored are required to make to each participant’s account
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Employer Responses to Rising Costs
Employers response to rapidly increasing costs by raising the share of costs paid by employees or limiting the employer’s contribution in other ways. Such as increasing employee contribution, co-payment, introduction of flexible plan, termination of benefits, etc. P48
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Health maintenance organization (HMO)
which are health care financing and delivery corporation that contract with doctors, hospitals, and other providers to provide services to beneficiates rather than cash reimbursement and through preferred provider organizations (PPOs)
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Flexible Spending Accounts (FSAs)
accumulate pretax salary deductions to be applied to the reimbursement of a variety of plan participant health care, dependent care and other benefits. Employees who do not use their entire FSA account funds forfeit their end of year balance to the employer sponsor.
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Health Savings account (HSAs)
permits individuals to accumulate pretax contributions to pay qualified medical expenses associated with high deductible health plans, which are defined as medical expense plans with an annual deductible exceeding $1,200 for an individual or $2,400 for a family in 2011.
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Medicare Supplement Policies
pays benefits for services not fully covered under medicare.
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Self-Funded Plans
claims are paid in cash as they arise with no element of prefunding through commercial insurance. The intent is to avoid the administrative costs of transferring individual risks. With self-funding plan, the employer essentially must recreate the services of a small insurance company and be mindful if they lack the financial capacity to satisfy cash flow strain in the event of extraordinary losses. Self-funding employers usually responds to these concerns by 1. Outsourcing administrative services and 2. Purchasing stop loss reinsurance to cover extraordinary claims.
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Stop Loss Reinsurance
reimburses a self-funded employer for claims incurred above certain limits and is available on an individual or aggregate basis.
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Medicare Part A
covers hospital and nursing home care facility charges.
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Medicare Part B
pays for physician, nursing and testing services as well as durable medical equipment such as mobility devices, prosthetic devices, and oxygen supply machines.
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Medicare Part C
Provide the option of receiving Medicare benefits under private insurance plans for beneficiaries with both Part A and B coverages under which benefits are more liberal than standard Medicare benefits and may require supplemental premiums by policyowner. Also known as Medicare Advantage Plans.
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Medicare Part D
provides prescription drug benefits under stand-alone plans that are distinct from Medicare Parts A, B, C. Part D coverage is available only through private insurance and subject to additional premiums.
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The Patient Protection and Affordable Care Act (Obama)
1. Basic Mechanics of Health Care under the Affordable Care Act – The program will be administrated by the federal department of health and human services (HHS). Individuals are required to maintain health care coverage. Failure to do so incurs fines of $695 for individuals and the greater of $2,085 or 2% of taxable income for families.
Employees with more than 50 employees are required to provide minimum coverage or pay fees to the government of $2,000 per each employee. Small employers are not required to provide coverage but are eligible for tax credits ranging up to 50% of contribution if they do provide coverage. Plan sponsors and insures will be required to maintain a minimum loss ratio of 85% for large groups and 80% for smaller groups. Health care must be provided on a guaranteed issue basis – no one can be declined. Lifetime benefit limits are abolished and coverage must be provided to dependents to age 26.
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Presumptive disability clause
an insured is always considered totally disabled, even if he is at work, if sickness or injury results in the loss of the sight of both eyes, the hearing of both ears, the power of speech, or the use of any two limbs.
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Benefit Period
is the longest period of time for which benefits will be paid under the disability policy. The longer the benefit period the higher the premium.
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Long Term Care Insurance Policies
About 70% of LTC policies are sold to individuals and through the group association market, with the remaining 30% sold in the group market. Essential elements of LTC include
i. The need for medical, personal, or social services,
ii. The need results from an accident, illness or frailty
iii. Services are provided by other persons, either paid or unpaid, at home or in an institutional setting, and
iv. Services are to assist the individual in performing the essentials ADLs
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Community Care
provide benefit payments for insureds who require assistance but who are able to remain in their homes or community. Usually as a percentage (i.e 50%) of the full nursing home benefit. Programs available are home health care, adult day care, respire care, hospice care, assisted living facilities (ALFs), therapeutic device or equipment, and modification to retrofit the insured home.
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Home health care
on a part-time basis and includes skilled nursing care, physical therapy, and related professional services as well as personal services such as assistance with ADLs.
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Adult day care
Provide assistance with ADLs and also allow socialization. It might be available in a LTC facility or a community program facility
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Respire care
provides temporary relief for family member providing care in the individual’s home by placing the individual in a LTC facility temporarily. (weekend)
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Hospice care
involves special care and emotional support for person diagnosed with terminal illness.
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Assisted living facilities (ALFs)
provide supervision, assistance, and limited health services to relatively healthy senior citizens. AFL provide less medical care than nursing homes, they complement, not substitute for, nursing care.
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Stock Life Insurance Co.
is a limited liability corporation authorized to sell life insurance that is owned by and operated for the benefit of shareholders who seek an adequate return on the capital they risk.
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Mutual Life Insurance co.
is a limited liability corporation authorizes to sell life insurance that is operated for the benefit of its policyowners who have quasi-ownership interest in the company. They do not issue stock, which means they do not have direct access to the stock market to raise equity capital, To raise additional capital: Quasi = partial
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Risk capital
are unencumbered benefits, is necessary to provide confidence to policyowner that their advocates that an insurer will remain solvent under reasonable extreme circumstances.
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Reserves
(reserve capital)– are actuarially determined investment funds dedicated to the payment of future policy benefits.
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Capital Asset Pricing Model (CAPM)
predicts that the share price of a company should reflect only the risk that does not affect all companies.
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Nondiversifiable risk or systematic risk
is that risk applicable to an entire market or class of assets or liabilities.
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general account
supports guaranteed interest-crediting contractual obligations, such as those arising from traditional and many contemporary life insurance policies, including WL and UL
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separate account
support variable life insurance and annuity liabilities for which all investment risk is borne by the policyholder.
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Hedging
is a strategy of acquiring securities whose gains and losses offset losses and gains in other securities or portfolios of securities. Hedging is achieved through the purchase of derivatives
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Derivatives
are traded securities or contractual agreements whose cash flows spend on the value of other specified securities or indices.
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C-1
asset risk - arising from defaults and changes in market values of investments
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C-2
pricing risk – arising from inadequate risk and expense charges
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C-3
non-market interest rate risk – arising from the correlation of asset and liability cash flow
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C-4
miscellaneous business risk. – That are not easily amenable to actuarial prediction
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Market risk
results from volatile values and uncertainty in financial markets that can affect expected cash flow.
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Over-ride commissions
The general agent’s agreement with the insurer typically provides for payment of over-ride commissions based on the agency’s first year premium production for new business. A separate override commission scale applies to premiums attributable to renewal business. Expense allowances are also paid as a function of first-year and renewal premiums, and bonus pay for performance may also be paid. Branch managers are generally paid a salary based on an incentive compensation formula that is generally not dissimilar to the general agents’ compensation. Bonuses for both focus on the same objectives.
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Direct Response Channels
serves purchasers directly without the initial intervention of an individual or institutional intermediary. It means that the sale is made by the company to the consumer without the aid of an intermediary and no sales commission are paid. The company solicits by mail, telephone, or media advertising, and the consumer’s purchase response is made by phone, mail, or internet communication. Direct response products are delivered and serviced more efficiently, and cost savings usually are reflected in the purchaser’s premium.
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Agent Compensation
– individual agent compensation generally varies with the nature of the distribution channel in which the agent works. The typical agent contract for whole life policies might provide for payment of a commission of 55% of first year premium, 5% of renewal premiums for a limited periods, such as 10 yrs, followed by a service fee of 2-3% thereafter for the life of the contract.
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Replacement
the sale of a new policy in contemplation of the lapse of an older policy and churning (repeated indiscriminate replacements) can significantly increase agent compensation without necessarily benefiting consumers.
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Churning
is the systematic and indiscriminate replacement of existing insurance with a new policy (based on misrepresentations) for purposes of securing new, higher commissions.
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Substandard
Classification subject to a higher than average mortality or morbidity
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Numerical Rating System
is a method under which an insurance company relies on a system of debits and credits representing adverse and positive expected marginal mortality rates, respectively, to derive an expected mortality classification for a proposed insured. A judgment of assessing debit/credits is applied to each risk to come up with a total. Classes are preferred, standard, substandard (usually over 130) or uninsurable (decline-usually over 500))
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Substandard risks
substandard risks are insureds who are expected or do exhibit higher than average mortality or morbidity.
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Multiple Table Extra
the most common method in which substandard risks are divided into broad groups according to their numerical ratings. Premium rates or mortality charges are based on mortality experience that corresponds to the average numerical rating in each class.
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Assumption Reinsurance
– total transfer of assets, liabilities, and risk from one insurer to another under which the assuming company legally replaces the ceding company in transactions on sections or book of business, and issues assuming certificates to affected policyholders.
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Facultative reinsurance
Reinsurance on a policy-by-policy basis under which applications received by a primary insurer are submitted to an assuming company that chooses whether to accept the risk based on its own underwriting standard.
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Automatic reinsurance (aka treaty)
reinsurance under which the direct writing company must transfer an amount in excess of its retention of each applicable insurance policy to the assuming company immediately upon payment of a direct premium and the issuance of the policy, and the reinsurer must accept transfers that fall within the scope of the agreement. The treaty always provide that not more than a certain amount per policy may be transferred to the reinsurance company, and the agreement may provide for a distribution of the excess to more than one reinsuring company.
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Quota share
Proportional reinsurance whereby premiums and claims are shared between ceding and assuming companies. The premium share is adjusted to reflect the direct writer's expenses.
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Stop loss
the reinsurer remits some or all of a ceding company aggregate claims above a predetermined dollar amount or above a percentage of premium during a specified period.
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Catastrophe
the reinsure covers claims that exceed a specified amount or number of insured due to a single event resulting in more than one loss, as in an accident or natural disaster.
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McCarron-Ferguson Act
passed by Congress in 1945 1945 to maintain the central role of the states in insurance regulation. The MFA sets out the division of responsibilities between the federal and state governments with the intent that responsibility be shared. It gives states the authority to regulate the "business of insurance" without interference from federal regulation, unless federal law specifically provides otherwise.
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Gramm-leach Bliley Act (GLBA)
of 1999 established a comprehensive framework to permit affiliations among banks, securities firms and insurance companies to share information. It allowed the creation under the BHC act of financial holding companies and authorized them to engage in a range of financial activities, including insurance underwriting and distribution, securities underwriting, trading, and merchant banking activities and banking.
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Dodd – Frank Wall Street Reform and Consumer Protection Act
was passed in 2010 in response to the subprime mortgage crisis and related financial turmoil experienced worldwide in 2008 and 2009.
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Unfair Trade Practices
disputes arising out of vanishing premiums, selling life insurance as a retirement plan without adequate disclosure, selling life insurance to tax-qualified plans, bonus annuities, and other practices. The most important agent prohibitions are rebating, twisting, and commingling and misappropriation of funds.
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Twisting
– which is the practice by an agent of inducing a policyowner through misrepresentation to discontinue an existing life insurance policy to purchase a new one. In contrast to replacement – discontinuing one policy to purchase another – twisting is illegal.
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Surplus strain
the impact on surplus of high expenses associated with the acquisition cost of business, together with reserving requirements, reduced current earnings and surplus.
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Cost accounting
is employed to make discrete expense analysis across different product lines, services, and operations
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Amortized value
is the difference between a bond’s acquisition cost and par value, increased or decreased in successive stages until the value equals the bond’s par value at maturity. The purpose of amortized value is to 1. Smooth the balance sheet effect of changing market interest rates on bond market value and 2. Reflect the assumed general intention of an insurer to old a bond to maturity, thus trivializing the effect of changing market values during the holding period.
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Admitted assets
those that may be counted in meeting an insurer’s statutory solvency requirements. Admitted values are the recorded values of the admitted assets.
a. Most traditional investment assets are admitted assets, while assets of questionable value or liquidity such as office equipment are non-admitted value.
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Policy reserves
The Asset Valuation Reserve (AVR) and Interest Maintenance Reserve (IMR)
– are statutory accounting mechanisms designed to prevent volatile fluctuations in reported surplus due to the changing market values of securities.
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Contributed surplus
is the amount paid for shares in excess of their par value
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SAP versus GAAP Treatment of Accounting Items – Three broad differences are
1. Valuation of Assets
a. SAP – Only admitted assets. Many bonds are amortized.
b. GAAP – all assets. Bonds are classified into three categories (HTM – reported at amortized value, Trading – reported at fair value with unrealized capital gains and losses included in earrings, AFS – reported at fair value with unrealized capital gains and losses excluded from earnings.)
2. Valuation of Liabilities – the principal difference in SAP and GAAP treatment of the valuation of insurer liabilities involve life insurance policy reserves and the payment of dividends.
a. SAAP – requires the posting of reserves that are based on statutorily defined, conservative assumptions regarding mortality and interest. Policy dividends reported are limited to the anticipated liability for the insurers following year.
b. GAAP – it uses assumptions that follow a company own experience or industry-wide experience. Policyowner dividends are reflected over the premium-payment periods of the contract. As dividends are paid, the balance sheet liability is reduced accordingly.
3. Recognition of Income and Expense
Income
a. GAAP – income is recognized when it is earned and not when it is received. Premiums are recognized as earned over the coverage period of policy in force.
b. SAAP – Premiums are recognized as earned over the premium-payment period.
Expense
a. GAAP – recognized that future income will be associated with first-year expenses and requires the deferral of those expenses in a way that reports the expenses ratably over a period of time. Cost related to future income are charged to future periods. Acquisition costs are capitalized as differed asset.
b. SAAP – fist year acquisition expenses generally are charged in full to the current year’s statutory income. The conservative requirements do not allow for their amortization over the anticipated premium payment period.
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Capital Requirements
a. Total adjusted capital (TAC) equals statutory capital, paid in surplus, the asset valuation reserve, and, in the case of mutual companies, 50% of any declared and unpaid divided.
b. Authorized control level (ACL) is derived by a formula that reflects the insurer’s particular risk, including asset risk (affiliates) (C0), asset risk (other) (C1), insurance risk (C2), interest rate risk (C3), and business risk (C4). CH9
c. RBC must be maintain to avoid regulatory intervention. The “gag rule” prohibits agent or insurer from disclosing RBC data “directly or indirectly” to the public.
RBC Level Trigger Point % (TAC/ACL) Required Action
No action 200 or more No action required
Co Action Lev 150-200 RBCplan required
Regulatory Action Lev 100-150 RBC plan and corrective orders required
Authorized Control Level 70-100 Possible regulatory control
Mandatory Control Level Below 70 Mandatory regulatory control
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Asset liability risk
(ALR) – arises from the possibility that the same external factors can affect the value of assets and liabilities simultaneously and disproportionately, the most important of which is a change in market interest rates.
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Operating capital
is the amount of invested and accumulated nonfinancial assets, intangible, and liquid working capital required to do business but not available to pay claims.
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Reserve capital
is the amount of financial assets held by an insurer to pay its expected claims
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Risk capital
is the amount of financial assets held by an insurer to pay unexpected claims. Is necessary to provide confidence to policyowner and their advocates that an insurer will remain solvent even under reasonable extreme circumstances.
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The Importance of Capital and Capital Structure
The Capital Asset Pricing Model (CAPM) principle are used to derive the value of risky stocks and the implicit returns investors require to bear that risk. Is used in the pricing of risky securities. Two important implications of these principles apply to nonfinancial companies
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Value at risk
(VaR) is the maximum acceptable loss associated with an asset or liability or portfolio of assets and liabilities over a specified time period with a specified probability or confidence level.
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Asset-liability matching
ASL is the practice of designing policies and managing liability-machined asset portfolios to interact in a way that protects an insurer’s net surplus position under changing economic conditions and customer behavior. It is a short straddle position.
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Economic capital
– (EC) is the amount of capital require to absorb the maximum expected loss occurring with a specified probability over a specified time horizon.
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Dynamic financial analysis
(DFA) – is a stochastic or probability-based projection of an insurance company’s cash flows and financial conditions over time, taking into account a full range of economic scenarios, asset and liability cash flows, the mutual dependences or interrelationships of the cash flows, and the factors that affect cash flows individually and collectively.
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Monte Carlo method
applies randomly selected values to variables in a deterministic cash flow model that is repeated thousands of times to produce a range of possible results and their probabilities. As the number of simulations increases, the reliability of the range of results is expected to increase in accordance with the law of large numbers.
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Immunization
is the practice of structuring assets and liabilities so that a change in interest rates will affect asset and liability values equally such that surplus capital is unaffected.
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Duration matched
when changes in its asset values will be exactly offset by changes in liability values when market interest rates change. Total assets = Total liabilities and surplus capital.
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assumption reinsurance
that transfers all assets and liabilities associated with a specified block of business to a reinsurer (which often requires policyowner approval)
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Capital Asset Pricing Model (CAPM)
an extension of MPT, is used by securities analysis to value securities. CAPM connects market risk to the investor’s required rate of return and provides an intuitive way of thinking about the return an investor should require from an investment, given the asset’s systematic risk.
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Beta
is a measure of the sensitivity of a security’s return to the market return in a well-diversified portfolio. Measure of the volatility or variance of a stock’s performance relative to the performance of the stock market as a whole.
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Duration
: can be thought of as average life of an asset or liability. Weighted average time to maturity of a fixed income asset or liability or portfolio of fixed income assets or liabilities.
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The Duration Formula
Characteristic of duration: 1. Duration increases with increases in the maturity of fixed-income asset or liability 2. Duration decreases with increases in the yield to maturity.3. the lower the coupon or interest payment, the lower the duration.
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radix
With a mortality table, arbitrary number of person assumed to be alive at the youngest age for which death rates are shown.
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Basic mortality table
reflects the actual experience of the population from which the data were drawn.
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A valuation mortality table
is used as the basis for calculating minimum reserves and cash values. These tables usually contain margin.
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present value
The value today of a future payment (or series of payments) discounted for interest is its present value.
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Temporary life annuity
Life annuity payable for the lesser of a set number of years or until the annuitant dies. a life annuity for a set term of years (but terminating if and when the individual dies during the set term)
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Annuity certain
makes payments for a set period of time without reference to whether the annuitant is alive.
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Loading
amount added to a net premium to derive a gross premium and designed to cover an insurer’s expenses of operation, taxes, profits, and a margin for contingencies.
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gross premium
When the net premium is loaded for these items, we obtain the gross premium – the amount charged policyowner’s. Net premium plus loading. = Gross premium.
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Net Single Premiums (NSP)
is the present value of future benefits promised under a life insurance policy. Its computation requires information as to:
o 1. The age and sex of the insured,
o 2. The benefits to be provided,
o 3. The mortality rates to be used,
o 4. An interest rate. Probability of dying formula concept
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Net Level Premiums
the periodic premium equivalent to the NSP annualized over a specified premium payment period. Such premiums will be paid during the life of the insured or for a limited number of years, but always cease upon the insured’s death. Note that this is the definition of a life annuity.
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GAAP versus Statutory Reserves
Deferred acquisition cost. – assets under GAAP representing that portion of first year policy expenses incurred by an insurer not changed against income in that year and amortize, usually over the premium paying period, via a charge to income in those later years.
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Concepts of Equity
The actual treatment of withdrawing policyowner’s can be based on at least three possible concepts of equity. They are that terminating policyowner’s should receive:
a. Nothing
b. A surrender value equal to the policy net level premium reserve, or
c. A surrender value based on the policy’s asset share.
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Mortality margin
amounts added to underlying mortality rates to develop actual mortality charges under a policy.
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Expense margin
also called safety margin, is intended to provide for contingencies, for profits or surplus accumulation, and/or to cover losses associated with early policy lapses.
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Return on investment (ROI)
is the ratio of the present value of expected profits to the initial surplus employed to support the product for a set number of years, such as over the life of the product or sometimes yearly. Companies strive for an ROI of 15 or so.
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Internal rate of return
s the rate of interest that causes the present value of profits to be zero
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Return on equity
(ROE) is the ratio of annual expected profits to equity for a product for a set period of time, usually for a single year.
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Return on assets (ROA)
is the ratio of profits to the assets that result from a product for a set period of time, often for a single year.
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Break even
is the number of years that will have passed before earnings equal disbursements.
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Hurdle rate
is the minimum acceptable investment return an insurer expects from a new product.
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The Asset Share Model
is a simulation of the anticipated operating experience for a block of policies, using the best estimates of what the individual factors will be for each future policy year.
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A.M. Best
has been publishing financial information about insurance companies for more than a century. Insurers pay an annual fee to be rated.
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Regulatory Control over Policy Provisions
regulators do not mandate forms, however, they exercise considerable control over insurance contracts by requiring prior approval of policy forms that must contain specific provisions
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Adhesion
meaning that its terms and provisions are fixed by one party (the insurer) and with minor exceptions, must be accepted or rejected word for word by the other party (The prospective policyowner). “Take it or leave it”
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Valued policies
meaning that the insurer agrees to pay a stated sum of money irrespective of the actual economic loss
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Indemnity
insureds suffering a covered loss are entitled to recover an amount not greater than that which would be necessary to pay the insured in the same pre-loss financial position.
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Aleatory
life insurance contracts outcomes are governed by chance and that one of the parties may obtain more than the other
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commutative
means that they carry an approximately equal exchange between the contracting parties.
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void agreement
has no legal force or effect
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voidable agreement
can be made void at the option of the innocent party
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Repudiation
is the express act of voiding a policy.
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Age of majority
the minimum age at which a person can enter into a contract
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Estoppel
the principle that prevents one from denying or asserting any position contrary to that established by the individuals own conduct or by previous legal determinations. From website: Estoppel is a collective name given to a group of legal doctrines in common law legal systems whereby a person is prevented from asserting certain matters before the court to prevent injustice
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Concealment
is the withholding of information and courts have repeatedly relied on the concept of utmost good faith to invalidate polices where it is deemed the withholding of material facts by either party rendered the risk actually insured different from the intended.
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illustration actuary
must make certain annual certifications to the insurance regulator and the insurer’s board of directors regarding the insurer’s practices and compliance with regulation. The actuary must certify that illustrations rely on a disciplined current scale (DCS).
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DCS discipline current scale
: that schedule of current nonguaranteed values shown in a basic illustration for which each set of implicit assumptions is based on the insurer’s actual recent current, determinable, and credible experience.
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Variable Life Insurance Illustrations
subject to FINRA standards and guidelines. FINRA regulates securities firms and is dedicated to investor protection.
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Value Solve Measures
is the term for a category of three performance measures commonly used within the life insurance industry that involve the production of policy illustrations that solve for a dependent policy element by setting the other major policy elements equal to each other.
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Investment capital
income from financial and real estate. At an individual retirement, human capital will be exhausted, and income from financial and real estate are required to support the individual through the end of life.
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Wage risk
is the possibility that an individual earnings from employment are less than expected
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Mortality risk
the possibility that a budgeting and savings program designed to support an individual or family to and through retirement is not completed due to the death of a breadwinner during the working life. Mortality risk is transferred via life insurance
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Savings risk
is the possibility that unexpected expense, a lack of planning, or carelessness impedes or interrupts the planned conversion of human capital to investment capital
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Longevity risk
is the possibility that an individual will live to an unusually old age and that his or her financial assets will be insufficient to complete an orderly plan of investment asset liquidation designed to last a lifetime. Longevity risk is transferred via life annuities
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Inflation risk
(Environmental) - the possibility that the cost of living will exceed that anticipated during life. During the working life, inflation risk is largely hedged though a competitive wage. Inflation risk is especially important in two other respects. First, health care inflation has been even greater than the general rate of inflation. Second, during retirement, the competitive wage hedge ends, thus exposing the retiree to additional inflation risk in both general living and health costs. Inflation risk can be addressed with asset allocation in general savings, through variable annuities and life insurance, and in the relative amounts allocated to insurance and noninsurance products. It can be addressed with inflation-indexed bonds and annuities.
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Investment asset risk
(Environmental) p515 possibility of poor relative investment performance. Performance can be poor due to (1) suboptimal (or negative) returns for a give level of risk, (2) an inappropriate level of risk, and (3) negative real returns when the earned rate does not exceed the rate of inflation. Investment asset risk is treated through rational asset and portfolio construction.
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Basis or cost basis
(aka tax basis and investment in the contract)is the sum of premiums + contributions – refund, dividends, cash, surrender, or other withdrawals)
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Premiums
Premiums for life insurance policies are generally not deductible for individuals or for businesses. Exceptions exist when:
a. The policy is owned by and for the benefit of a qualified charity or charitable trust
b. The policy is owned by an employer, the policy is payable as an executive bonus, and the executive includes the value of the premium in taxable income; and
c. The policy is payable to an ex-spouse OR children under an alimony agreement.
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Policy Loans
Personal loan interest is not deductible, and the rule applies to policy loan interest.
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Adverse selection
aka antiselection. Is the tendency of self-selected insurance applicants to exhibit average claim experience greater than that of a randomly selected group of insureds, representing an asymmetric information problem resulting from the fact that the customer knows more than the seller about the customer’s situation and uses that fact to the seller’s detriment.
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Moral Hazard
results when the presence of insurance changes the loss prevention behavior – called ex ante moral hazard – or loss minimization behavior – called ex post moral hazard of the insured or beneficiary. An idea that a party that is protected in some way from risk will act differently than if they didn’t have that protection. Insured becomes less risk adverse.
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Rebating
is the practice by an agent (or insurer) of giving something of value (i.e. portion of the agent’s commission) not specified in the insurance contract to an applicant in return for the purchase of a policy.
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Solvency
Owner's equity= assets - liabilities
| Surplus (capital) = PV of assets - PV of liabilities
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Profitability
earnings=revenue-expenses
| NI=Premiums = investment income - expenses - net change in reserves
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Liquidation
is the complete and final termination of an insolvent insurer’s operations under provisions of state insurance law that permit the insurance regulator under court approval to entirely dispose of all assets and liabilities in accordance with that law
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Due care
requires that those offering life insurance advice conduct their business affairs with diligence, prudence, and competence, such that recommended insurance is suitable for the individual’s circumstances, reasonably expected to offer good value, and procured from insurers that are financially sound.
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due diligence
diligence as applied to variable products and other securities, process by which a broker/dealer ensures that an investment is as represented. a comprehensive appraisal
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Gross estate
the starting point for estate tax computation, is composed of the value of the decedent’s interest in all property. The gross estate is derived by summing the values of each of the categories (property owned by the decedent, certain gifts, annuities, joint interest property, life insurance).
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escheats
a condition under which unclaimed property passes to the state.
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Probate property or wills
is a legal declaration of an individual’s wishes as to the disposition of his or her property on death.
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Intestate succession statute
state law that determines the identity of heirs and their shares of distributed property of a person who died intestate. The distribution is based on the degree of individual’s consanguinity (Blood relationship) to the descendent rather than the decedent intentions.
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advance directives
are legal documents that provide one’s family and physicians with written instructions regarding ones preferences regarding medical treatment in the face of serious medical conditions. “These documents speak for you when you’re unable to speak for yourself.” For types of advance directives are living will, medical power of attorney, durable power of attorney, and dnr order (do not resuscitate).
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Living will or inter vivo trust
is an advance directive setting forth the individual’s wishes as to the use of life sustaining measures in case of terminal illness, prolonged coma, or serious incapacitation.
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testamentary trust
trust created at death through a person’s will
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Crummey trusts
(within an irrevocable trust), gifts to the trust qualify as present interest gifts and thus the annual gift exclusion, by providing trust beneficiaries a reasonable opportunity to demand distribution of amount contributed. Gift do not qualify for the annual exclusion if beneficiaries do not withdraw any property from the trust during the defined period.
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Behavioral economics
is a positive or descriptive discipline that seeks to understand how psychological factors such as cognitive bias can influence how investors, savers, and other economic actors make economic decisions.
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3 types of defined contribution (DC)plans are
Profit sharing plans, employee stock ownership plans, and 401(K) plans
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Employee stock ownership plans
permit share of the employer-sponsor stock to be contributed to the plan and assets of the plan to be invested in the stock of the employer-sponsor.
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401(K) plans
permit employees to defer some of their compensation on a pretax basis; these plans may also allow employers to make qualified matching contributions.
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IRA (individual retirement account)
• Tax qualified plan, Only if the person is not covered by a qualified plan are IRA contributions fully deductible, and taxation on the asset investment returns is deferred.
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Limited liability companies
a new form of business combining features of partnerships and corporation, whose governance and owners’ rights are defined more by the operating agreement of its members than by stature, featuring limited liability and flexibility in the tax status of participants.
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Key person insurance
is purchased to indemnify a business for the decrease in earnings brought about by the death of one or more key persons. Could be employed or not employed but whose death could adversely affect a business.
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Business overhead expense insurance
covers the monthly business expenses of business owners and professionals in private practice if they are disabled.
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Key employee disability insurance
provides for payment of a monthly indemnity to business entity during the total disability of an essential employee who is the named insured under the policy.
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Once-way buy/sell agreement
obligates the estate of a sole owner of a business (including a corporation) to sell and another party to purchase the owner’s interest.
