Chapter 24: Pricing and Financing Strategies Flashcards
What is the difference between the cost of benefits and their price?
The cost of benefits is the amount that should theoretically be charged for them.
The price of benefits is the amount that can be charged under a particular set of market conditions and may be more or less than the cost.
What factors influence the price of benefits?
Factors influencing the price include:
- the distribution channel(s) used
-> 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
- the level of competition in the market
-> there may only be a limited number of providers in
the market and so higher premiums can be charged.
-> there may be lots of providers in the market, so
premiums will fall
- the approach taken to expense and profit
loading, e.g.
-> marginal costing: taking a lower or no contribution to
expense overheads and profit
-> loss leading: cheap, loss making product may attract
customers to other, more profitable products of the
company
- the provider may have a captive market
that is not price sensitive, such as an affinity group
Once a price has been determined, it should be profit tested and market tested.
How should the cost of benefits be calculated?
The premium(s) (or contribution(s)) should be calculated by equating the value of premiums with the value of benefits and expenses plus a contribution to profit.
This should then be adjusted to take into account other factors such as:
- tax
- commission
- cost of capital
- contingency margins
- options and guarantees
- provisioning bases
- experience rating
- investment income
- reinsurance costs
What are the main methods of financing benefits?
The main methods of financing benefits are:
- pay-as-you-go (unfunded)
- funded
-> lump sum in advance
-> terminal funding
-> regular contributions
-> just-in-time funding
-> smoothed pay-as-you-go
What influences the choice of method of financing benefits?
The choice of financing strategy might depend on:
- whether the government has used the tax system to make some approaches to financing more advantageous than others
- the way in which the approach to the incidence of funding affects the allocations of risks between the individual and company
How is the cost of benefits calculated for a benefit scheme?
Under a defined benefit pension scheme, the calculated contribution rate is typically set to meet the value of future benefits and expenses.
What might cause the actual contribution rate (price) to differ from the calculated rate (cost)?
The actual contribution rate may be different to the calculated rate:
- so as to rectify any shortfall or surplus in the pension scheme
- to reflect the sponsor’s desire to pay less or more into the scheme
- due to legislative constraints
Pay-as-you-go
Benefits are met out of current revenue and there is no funding.
Smoothed pay-as-you-go
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.
Just-in-time funding
Funds are set aside only in response to an external event such as the sale of an employer.
Terminal funding
A lump sum is set aside to cover all the expected benefit costs when the first tranche of business becomes payable.
Lump sum in advance
A lump sum is set aside to cover the expected benefit cost when the benefit is promised.
Regular contributions
Funds are gradually built up between promise and first benefit payment.
List the different distribution channels
- independent intermediaries
- tied agents
- own sales force
- direct marketing
Direct marketing
Press advertising, over the telephone, internet or mailshots.
