Chapter 6: Life Insurance products

Question 1

List 15 life insurance products

Answer 1

• Term assurance (level)
• Term assurance (decreasing)
• Term assurance (renewable)
• Term assurance (covertable)
• Endowment assurance
• Pure endowment
• Whole life assurance
• Critical illness
• Long-term care
• Income Protection
• Immediate annuities
• Deferred annuities
• Income drawdown
• Investment bond
• Key-person cover

Question 2

Key features of insurance contracts

Answer 2

• Long-term
• Usually one claim
• The claim amount may be known with certainty
• Used for protection against the financial impact of death, ill health and for savings
• May be sold to individuals or group basis

Question 3

How are profits calculated for life insurance contracts?

Answer 3

Premiums net of reinsurance premiums paid
+ Investment income and gains
- Claims net of reinsurance recoveries
- Expenses and commission
- Increase in provisions
- Increase in the cost of capital
- Tax
= Profit

Question 4

Assumptions needed in Life Insurance

Answer 4

• Premium rates per policy
• sales volumes and mix of business
• Investment returns e.g. bond yields
• Expense levels
• Expense inflation
• Commission rates
• mortality rates
• morbidity rates
• withdrawal rates
• seperate assumptions to calculate the provisions
• solvency capital requirements
• tax rates
• reinsurance premium rates and recovery rates

Question 5

Define new business strain

Answer 5

usually, in the first month of a life insurance contract, the insurer receives a premium, but has to pay out commission, initial admin and underwriting expenses, set up provisions and any required solvency capital. if the outgo is more than the income, this is called the new business strain.

Question 6

Key Life Insurance Contract risks

Answer 6

• mortality, longevity and morbidity
• investment risks e.g. poor returns, credit risk
• expenses, not met by premium loadings or charges
• early withdrawels, before the initial expense have been recovered
• new business volumes too high and hence new business strain, or too low and not enough business over which to spread overheads
• credit risk, failure of counterparty such as reinsurer or a broker
• operational risks, e.g. fraud, system failure, regulatory changes

Question 7

Pure endowment and endowment assurance

Answer 7

• Pure Endowment provides a benifit on survival to a known date and hence operates as a savings vehicle
• Endowment assurance also provides benefit on the death of the life insured, operates as a vehicle of dependent protection

Uses:
* transferring wealth from parents to children
* repaying capital on a loan
* savings vehicle

Form
* without-profit, with-profit, unit-linked

Group Version
* Employer provide some form of insurance cover or savings benefit to employees as part of their overall remuneration package

Question 8

Whole life assurance

Answer 8

Provides a benefit on the death of life insured whenever that might occur.

Uses
* Long-term protection to dependants
* funeral expenses
* tax liabilities

Forms
Without profit, with-profit, unit-linked

Group
no need (employers would want to restrict life cover to the period of employment)

Question 9

Term assurance

Answer 9

• Provides a benefit on the death of the life assured provided it occurs within the term selected at outset.
• As the policy will not pay a benefit in every case, the cost is usually cheaper.
• Normally don’t have any benefit paid on withdrawel (increase risk of selective withdrawel)

Needs
protection agaist financial loss for the assured’s dependants

Question 10

Give examples of customer needs met by a group version of a term contract

Answer 10

• An employer could take out TA on its employees to provide a death in service benefit, which pays out if an employee dies
• A credit card company can take out a group TA on its credit card holders to pay off any balance outstanding on the death of the cardholder
• A supplier of goods with payments in installments could take out a group TA on its payees to cover the difference between the amount owing and the value of the recovered goods upon the death of the payee

Question 10

Decreasing term assurance

Answer 10

It may provide a lump sum on death, a lower amount being paid the later death occurs in the contract term, or the contract may provide an income for the rest of the contract term.

Needs
repayment of loan
provide income for dependants

Question 11

Convertible / renewable term assurance

Answer 11

Combine a term assurance with the certainty of being able to either convert to a permanent form contract (whole life, endowment) or to renew the original contract for a further period, all without further evidence of health being provided.

Group
A comparable group arrangement would be the option for an individual in a scheme covered by a group life policy to convert to some form of individual arrangement on leaving the scheme

Question 12

Immediate annuity

Answer 12

Involves a single premium purchasing an income stream, which commences immediately after purchase

Limited period are called temporary annuities

Form
Usually without-profit or index-linked

Needs
income for the remainder of life

Group Version
can be used by an employer to fund for pensions for employees after retirement

Question 13

Deferred annuity

Answer 13

Can be used when there is the time between date of purchase and the date when the income is required to start.
The contract can be paid for either by a single premium or by regular premiums during the deferred period.

Needs
Build up pension that becomes payable on retirement
An alternative lump sum may be offered at vesting date of annuity to pay off a loan

Group version
can be used by employer to fund for pension for employees

Question 14

Income drawdown

Answer 14

Allows an individual to leave their accumulated fund invested and draw an income from it annually. May be limits on how much can be drawn down each year and an age limit at which point an annuity must be purchased.

Needs
Should the member die before having a secured annuity, the member’s heirs can inherit the balance of the fund

Group Version
none

Question 15

State 5 risks for the member of an income drawdown product

Answer 15

• If only the income earned on the fund is taken each year, the member’s income could be volatile
• if too high level income is taken, the capital could 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 administrating and arrangement may be high
• The remainding fund on the member’s death may be insufficient to provide adequate benefits for a dependent
• There may be tax charge on the residual fund on the member’s death

Question 16

Investment Bond or Investment-linked insurance policy

Answer 16

These are single premium contracts, normally whole life, designed to enable policyholders to invest for the medium to long term.
* can usually make withdrawels
* may incur a penalty in the first few years
* restrictions on the frequency with which withdrawels can be made
* On death, the bond will pay a lump sum

Needs
* higher returns on funds
* minimum payout on death to cover family’s costs
* withdraw for additional funds

Form
guarantee, unit-linked or investment-linked

Group Version
None

Question 17

Income protection

Answer 17

Enables individuals to provide income for themselves and their dependants during a period of long-term sickness or incapacity due to accident or illness.
Typically terminate at retirement age.

Group Version
Can be used by an employer to provide a sick pay scheme for employees

Question 18

Critical illness

Answer 18

Provides a cash lump sum on the diagnosis of a “critical” illness as defined by the policy documents.

Type
Without-profit, unit-linked

Group version
used by an employer to provide financial security for employees in the event of contracting a critical illness

Question 19

Key person cover

Answer 19

Pays a lump sum on death or critical illness of a key individual within a business. The benefit may be linked to loss of profits or the salary of the individual and used to buy out the individual from business or find a replacement

Group version
Key person insurance is purchased by a company for its own benefit, covering particular employees. it is unlikely to be purchased as a “group” version

Question 20

Long-term care

Answer 20

The contract can be used to help provide financial security against the risk of needing either home or nursing home care as an elderly person, ie post-retirement.

• pay for all the costs of care througout the remainder of life (an indemnity contract)
• could provide a cash lump sum or annuity to contribute towards the costs of care
• reached a specified level of disability
• unable to perform a specified number of activities of daily living (ADLs) due to physical impairment
• not be able to perform them unsupervised due to mental impairment
• paid for by single or regular pemium
• regular premiums would cease from the point at which claims begin to be paid

different levels of care
- cost of care in own home
- cost of being cared for in a residential (but non-nursing) home
- cost of being cared for in a residential nursing home

Form
without-profit, with-profit, unit-linked, investment-linked

Group version
enable an employer to provide long-term care cover to employees and their dependants

Question 21

Under what circumstances are benefits paid under:
1. critical illness cover
2. income protection contract
3. long-term care contract

Answer 21

1. Critical illness - on diagnoses of a critical illness as set out in the policy documentation
2. Income protection - during periods of incapacity due to accident or illness
3. Long-term care - when the insured needs home or nursing home care

Question 22

List 4 main investment types for insurance contracts

Answer 22

• Without profit
• With-profit
• Unit-linked
• Index-linked

Question 23

Without profit

Answer 23

Benefits are fixed at outset.

The insurer bears the risk of experience not being as expected but also receives the profits.

Typically used for protection products but also for savings.

Question 24

With profit

Answer 24

Profits and risks are shared between the policyholder and the insurer. There are both guaranteed and discretionary benefits. Typically used for savings products but also for protection. When setting the levels of bonus include: - the wish to smooth benefits from year to year, so keeping back some of the profit from the good years, to help in the bad years - policyholder expectations e.g. based on past bonus distributions of the company - looking at what competitors are doing - adhering to regulatory limits on payouts

Question 25

Unit linked

Answer 25

Benefits depend on the performance of the underlying assets. Experience risks are generally borne by the policyholder, unless there is a minimum guaranteed benefit. Used for both savings and protection products, but normally only where there is a significant investment element.

Question 26

Index linked

Answer 26

Gives a benefit that is linked to the performance of an economic or investment index. Premiums may move in line with the same index, or may be fixed in monetary terms.