Chapter 6 Flashcards
(17 cards)
What are the key features of life insurance contracts? (6)
▪ They are often long-term.
▪ There is typically only one claim.
▪ The claim amount (sum assured) may be known with certainty.
▪ They are used for protection against the financial impacts of death or
ill-health, and for savings.
▪ They may be sold to individuals on a group basis.
▪ They are subdivided by investment types: with-profit, without-profit,
unit-linked, index-linked.
what is the most common form of underwriting for life insurance?
medical underwriting
what are the premiums for life insurance set by? (2)
formula
profit-testing model
In addition to provisions, what is an insurer required to hold?
minimum level of solvency capital to provide greater security that the policyholder benefits will be paid
key risks the life insurer is exposed to (7)
▪ mortality risk (too many deaths), longevity risk (living too long) and
morbidity (sickness).
▪ investment risk, e.g., poor, or volatile returns, falls in assets values, default risk.
▪ expenses, not met by premium loadings or charges.
▪ early withdrawals, before the initial expenses have been covered.
▪ new business volumes too high and hence new business strain, or too low and not enough business over which to spread the overheads.
▪ credit risk, i.e., failure of a counterparty such as a reinsurer or a broker.
▪ operational risks, e.g., fraud, systems failure, regulatory changes.
Life insurance products? (12)
- Whole life assurance
-Provides a benefit on the death of the life insured whenever that might occur.
-funeral expenses, inheritance tax, financial protection for dependants, tax efficient way to transfer wealth
-NO - funeral insurance
- Term assurance
-provides a benefit on the death of the life assured provided it occurs within the term selected at outset
-credit life, financial protection of dependants
-YES - Convertible or renewable term assurance
-Combine a term assurance with the certainty of being able either to convert to a permanent form of contract (ie an endowment or whole life assurance) or to renew the original contract for a further period, all without further evidence of health being provided (unless the benefit level is increased)
-financial protection
-YES - Pure endowment
-provides a benefit on survival to a known date and hence operates as a savings vehicle. - Endowment assurance
-provides significant benefit on the death of the life insured,
operates as a vehicle of dependent protection.
-transferring wealth, repayment of loan capital
-YES - Immediate annuity
-An immediate annuity involves a single premium purchasing an income stream, which
commences immediately after purchase.
-financial need for income for remainder of insured’s life
-YES - Deferred annuity
-Used when there is a period of time between the date of purchase and the date when the income is required to start
-build-up pension before retirement, lump sum option at vesting date
-YES - income drawdown
-allows individuals to leave their accumulated fund invested and draw an income from it (may be the income only or part of the capital)
-there may be limits on how much to draw and an age limit to when an annuity must be purchased (legislation)
-dependants can inherit the fund value if they die before securing an annuity (not the same for an annuity)
-NO - investment bond
-These are single premium contracts, normally whole life, designed to enable policyholders to invest for the medium to long term.
-lump sum on death, earn higher return, ensures minimum payout on death (guarantee) - funeral costs, inheritance tax, can withdraw from fund when money needed
-NO - ## income protection insurance
- critical illness insurance
- key person cover
- Long-term care insurance
An insurance company uses the following tools to ensure that a policy is and remains ‘insurable’ (4)
- Product design and pricing
- Underwriting
- Claims assessment
- Monitoring and the control cycle
What are the 4 main risks addressed by life insurance products?
-dying too soon (losing the future income asset)
-having reduced ability to work
-becoming disabled
-living too long (longevity risk)
How can one’s future mortality be assessed? (7)
-family history (medical underwriting)
-existing medical conditions
-standard of living
-medical history
-occupation, pursuits and hobbies
-behaviour and habits
-socio-economic level (income and education)
What happens if one procrastinate buying mortality protection? (3)
- The higher the probability of not
being eligible - The more likely you are to be charged extra rates
- The greater the likelihood that your intended purchase will be too late
The types of assets that life insurers usually hold: (6)
- Fixed-interest bonds to meet liabilities that are guaranteed in
money terms. - Real assets (index-linked bonds, equities and property) to meet
benefits that are inflation linked e.g., stream of index-linked
annuity payments and expenses. - Equities and property to maximise returns, e.g., to be able to
provide discretionary benefits. - Assets which match the term of the labilities which are
predominantly medium to long-term, but some shorter-term
assets will be needed to meet immediate cashflow
requirements, e.g., benefit payment. - Assets predominantly denominated in the domestic currency.
- Some derivatives to hedge guarantees and options.
Why do life insurance companies need capital? (8)
▪ To cover the outgo incurred in writing new business (new business
strain)
▪ To cover unexpected events - such as adverse claim experience, or a
miss-selling fee
▪ To give investment freedom - the more free assets, the greater the
ability to mismatch in pursuit of higher returns.
▪ To demonstrate financial strength - capital helps the insurance
company to look strong, which encourages brokers and policyholders
to place business with the company, and credit rating agencies to award
a higher rating.
▪ For opportunities - capital can be used for ventures such as mergers
and acquisitions
▪ To smooth dividends/bonuses
▪ For development expenses - e.g., product development, advertising,
marketing costs
▪ To cover guarantees - contracts with guarantees tends to have more
onerous provisioning requirements than contracts without guarantees.
Components of profit for life insurance contracts:
▪ + Premiums net of reinsurance premiums paid.
▪ + Investment income and gains
▪ - Claims net of reinsurance recoveries
▪ - Expenses and commission
▪ - Increase in provisions (reserves)
▪ - Increase in the cost of capital
▪ - Tax
▪ = Profit
Reasons why a life insurer monitors experience? (10)
▪ to set assumptions for premium rating.
▪ to set assumptions for provisioning and to monitor the paid claims
against expectations.
▪ to assess the profitability of its business and the key components of
profitability.
▪ to assess reinsurance requirements and to monitor the adequacy of
reinsurance.
▪ to determine an appropriate investment strategy.
▪ to determine capital requirements.
▪ to assist with financial planning and strategy.
▪ to provide management information.
▪ to help with marketing new products
▪ NB: Should monitor any item of experience related to profits.
Life insurance products are usually sub-divided by 4 investment types:
- With-profit contracts
-policyholder is entitled to receive part of the surplus of a company or a sub-fund within the company
-extent is at the discretion of the company
-insurer and policyholder share profits hence the risk (appropriate when need is saving)
-invest in riskier assets than without-profits for higher return - Without-profit contracts
-life insurer has no discretion over the amount of benefit paid out (guaranteed)
-customer knows at outset the premium and benefit amounts but surrender values are at the discretion of the insurer
-certainty means less risk for the policyholder (good when primary need is protection) - Unit-linked contracts
-unitised contracts whose value of
units is directly attributable to the underlying value of the
invested assets.
-The benefit payable at maturity depends on the performance of
the underlying assets and the level of charges levied by the
insurance company.
-insurer gets profit from expenses charged higher than actual expenses and mortality charge higher than cost of providing the death benefit (hence risks are expenses and cost of benefit)
-the customer accepts significant investment risk as the expected maturity value might be higher under a unit-linked contract but could also be lower - Index-linked contracts
- consumer to obtain a benefit that is guaranteed to move in line with the performance of an index specified in the contract.
-premiums may move in line with the index or be fixed in monetary terms
-suitable investment assets would be domestic equities
What are the advantages (3) and risks (5) to the member of the income drawdown approach compared to purchasing an annuity at retirement?
Advantages
-The member may be able to earn a return on their invested funds (after tax and charges) in excess of that underlying annuity rates.
-The member has flexibility within the legislative requirements in terms of how much to take each year as an income.
-Annuity rates may currently be poor but improve in the future (at which time the member may be required by legislation, or chooses, to buy an annuity).
Risks
-If only the income earned on the fund is taken each year, the member’s income could be
volatile.
-If too high a level of income is taken, the capital could potentially reduce to zero before the member dies, leaving the member dependent on the state at the end of their life
-The charges taken in relation to administering the arrangement may be high
-The remaining fund on the member’s death may be insufficient to provide adequate benefits
for a dependant
-There may be a tax charge on the residual fund on the member’s death.
