Chapter 24: Pricing and financing Flashcards Preview

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Flashcards in Chapter 24: Pricing and financing Deck (25)
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1
Q

Cost of benefits

A

The amount that should theoretically be charged for them.

2
Q

Premiums should be calculated as…

A

The value of benefits and expenses plus a contribution to profit.

3
Q

Premiums/contributions should allow for… (12)

A
  • theoretical value of the BENEFITS to be provided
  • value of the EXPENSES that will be incurred
  • REINSURANCE costs
  • COMMISSION
  • contribution to PROFIT
  • PROVISIONING bases
  • OPTIONS and guarantees
  • the use of EXPERIENCE RATING to adjust future premiums
  • TAX
  • INVESTMENT income
  • COST OF CAPITAL
  • CONTINGENCY MARGINS
4
Q

Price of benefits

A

The amount that can be charged under a particular set of market conditions and may be more or less than the cost.

5
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
6
Q

Main methods of financing benefits

A
  1. Pay-as-you-go (unfunded)
  2. FUNDED:
    - lump sum in advance
    - terminal funding
    - regular contributions
    - just-in-time funding
    - smoothed pay-as-you-go
7
Q

2 Main factors affecting the cost of benefits

A
  • frequency of occurrence (affects the timing of the benefits)
  • severity (affects the amount of the benefits)
8
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.
9
Q

4 Examples of distributions systems

A
  • independent intermediaries
  • tied agents
  • own sales force
  • direct marketing
10
Q

Independent intermediaries

A

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

11
Q

Tied agents

A

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

12
Q

“own sales force”

A

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

13
Q

Direct marketing

A

Press advertising, over the telephone, internet or mailshots.

14
Q

Financing

A

A term used for putting a price on benefits payable on future contingent events, primarily in the context of benefit schemes.
The section looks at the timing (or incidence) of monies paid in, ie contributions.

15
Q

Unfunded

A

Find the money to pay for the benefit as the benefit falls due.

16
Q

Funded

A

To some extent, the monies to meet the benefit costs are set aside before the benefits fall due.

17
Q

Terminal funding

A

Funds that are expected to be sufficient to meet the cost of a series of benefit tranches can be set up as soon as the first tranche becomes payable.

18
Q

Regular contributions

A

Funds are gradually built up to a level expected to be sufficient to meet the cost of the benefit, over the period between the promise being made and the benefit first becoming payable.

19
Q

Just-in-time funding

A

Funds that are expected to be sufficient to meet the cost of the benefit can be set up as soon as a risk arises in relation to the future financing of the benefits (eg bankruptcy or change in control).

20
Q

Smoothed PAYG

A

Funds that are set up to smooth the costs under a pay-as-you-go approach to allow for the effects of timing differences between contributions and benefits, short-term business cycles and long-term population changes.

21
Q

2 Reasons the actual contribution rate may be different from the calculated contribution rate

A
  • the assets held are higher or lower in value than the accrued liabilities and thus there is a surplus or a shortfall.
  • The sponsor may want to change the pace of funding of the scheme by paying a higher or a lower contribution in any year.
22
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
23
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
24
Q

Why might a surplus arise in a benefit scheme? (3)

A
  • the assumptions about future experience were unduly pessimistic
  • the assumptions were reasonable but the experience turned out to be favourable
  • the sponsor paid more than the recommended contributions
25
Q

Why might the “price” of benefits be different from the cost? (3)

A
  • The provider’s distribution system may enable it to sell above the market price or take advantage of economies of scale
  • There may only be a limited number of providers in the market and so a higher premium might be charged.
  • The provider will also need to decide whether it is prepared to offer the business on a single premium basis or a regular premium basis or both. The provider may charge a higher regular premium in order to encourage policyholders to pay upfront.