Chapter 23 Flashcards
Contract Design (26 cards)
What is the acronym for the factors to consider when determining a suitable contract design?
RRaa ProFessor Megan’s BODDy EAAts 8C’s
What are the factors to consider when designing contracts? (20)
- Regulatory environment
- Risk appetite of parties involved
- Profitability
- Financing of the benefits (method)
- Market for the product
- Benefit form and level
- Options and guarantees
- Discretionary benefits
- Discontinuance benefits
- Expenses or charges
- Accounting implications
- Administration systems
- Contract terms and conditions
- Competitive pressures
- Capital requirements
- Consistency with other contracts
- Customer’s needs and interests
- Characteristics of other stakeholders involved in the contract design
- Contribution patterns
- Extent of Cross-subsidies
why consider risk appetites of parties involved? (1:3)
- sales are optimized if you sell a wide range of risk appetites
o savings products – range of investment choices (risk adverse – less equity content and blue chip companies and risk seeking – unquoted companies, emerging markets, high risk industries)
o GI products – range of risks that can be insured
o Banks – risk adverse investors-greater level of access=lower interest rates as there is no notice required to withdraw funds
The provider’s needs are influenced by? (4)
= chosen market
= capital available
= liquidity available
= expertise available
Customer’s needs are influenced by? (4)
= capacity to pay
= risks to be covered
= benefits that are needed at different times in the future
= attitude to financial risk
Other stakeholders involved in contract design: (6)
- Actuaries – initial costing, determining provisions, design process
- Lawyers – drafting contracts
- Accountants – ensures providers properly accounts for the income and outgo
- Financial backers – checks reports demonstrating proper stewardship of the finance provided
- Administrators – the more complex the product, the higher the cost of administration
- Sales and marketing – more complex, higher cost of training.
5 things that may be required by regulators relating to product design:
- Design must be consistent with legal or regulatory requirements
- Regulators may provide more attractive financial or taxation regime if the policy meets certain conditions
- Regulators may impose a cooling off period where customers can cancel and get a full refund within an initial period
- May be requirements on providers to present certain information to potential customers
- May be requirements to include TCF – ensuring fair treatment of customers is embedded in the firms culture
6 demonstrations of TCF throughout a product’s life cycle (FAIRSC):
- Fairness part of the business’ culture
- Appropriate design to meet needs
- Information clearly communication
- Right and Suitable advice given
- Service and performance that meet expectations
- Claims handled fairly
Variables that may affect profitability of an insurance product: (9)
- Claims frequency
- Claims severity
- Claims inflation
- options and guarantees
- expense and expense inflation
- investment returns
- withdrawal experience
- new business sales volume and mix
- capital efficiency
A surrender value can be set to recover: (4)
-expenses which have incurred
-expected profits on the contract
-penalty charge for breaking the contract
-the cost of any benefit payments up to the point of surrender
what are the two main types of competitive pressures?
- Product features
- Price (if contract is simple then it is crucial to competitiveness while complicated products are less easily comparable between providers hence not crucial to competitiveness)
What are the different types of options that can be offered? (8)
- Option to surrender (may have surrender values)
- option to convert from one type of policy to another
- option to increase or decrease premiums
- option to change payment frequency
- add rider
- no claims discount
- increase or decrease benefit
- option to renew
How would you price for options and guarantees?
charge can either be included in premiums (increase) or benefits (decrease) but these also increase capital requirements
What are guaranteed options?
guaranteed surrender value or continue with policy, option to use cash to buy a pension at aa guaranteed rate or take proceeds as a lump sum (these need clear explanations to customers)
What are discretionary benefit amounts based on?
A decision needs to be made about the extent to which the surplus arising is shared with the client (decision is based on the Policyholder’s Reasonable Expectation - PRE)
The surrender value can be set to recover: (4)
-expenses that have been incurred
-penalty charge for breaking the contract
-expected profit on the contract
-the cost of any benefits provided up to the point of surrender
When setting the discontinuance terms consider: (9) - DISCONtINuE
D – Difficulty of assessing discontinuance terms
I – Impact of selective withdrawals (good risks leave, bad stay)
S – Suitability of benefit amount (depends on what policy is worth - retrospective reserve, policyholder expectations and competitive considerations)
C – Cost of determining and applying the discontinuance terms
O – Options for benefit form (lump sum, annuity, etc.)
N – Not too frequent changes to the discontinuance terms
T
I – Industry or market practice
N – Need to meet regulatory requirements
U
E – ease of calculation
How to get the discontinuance benefit amount?
-GI - lump sum discontinuance payment reflecting the premium for the outstanding cover less an administration fee
- Defined contribution scheme - benefit will reflect the member’s account at the date of withdrawal and if it stays in the account it grows with investment returns less any charges
- Defined benefit scheme - may not always be fully funded and so the discontinuance benefit will reflect the funding (if its only 95% funded, then the discontinuance benefit will only be 95% of the benefit amount)
-discontinuance benefits in microinsurance are less likely as they would wish to keep costs low
What can discontinuance mean? (3)
-surrender
-lapse
-paid up (cease premium payments but cover continues, benefit may be reduced to reflect that no more premiums are being paid - paid up value)
What are the key principles used in microinsurance? (4)
-prepayment (premiums paid in advance - before risk event occurs)
-resource pooling (premiums are placed in a fund which funds claims)
-risk sharing (individuals reduce the financial burden they would face if they had to deal with the loss on their own by contributing to a common pool)
-guarantee of coverage (as long as premiums are paid, coverage is guaranteed)
What causes new business strain?
-high initial expenses
-initial commission
-initial increase in provisions
-initial solvency capital requirements
What are the different methods of financing benefits? (4)
- Funding all the benefit in advance (lump sum paid in advance)
- pay as you go
- regular payments over time
- terminal (paying an amount when the benefit event occurs)
pros and cons of greater flexibility in premium/contribution pattern: (2)
-P: enhance marketability and competitiveness
-C: complicated and expensive to administer
What is the main risk of cross subsidies?
That the mix is not a s expected (may sell a lot of small policies and few large ones when the large policies where to contribute more towards expenses than the small policies hence subsidising)
