Chapter 6: Life insurance products Flashcards
(24 cards)
What are the key features of life insurance contracts?
- Often long term
- Typically only one claim
- Claim amount may be known with certainty
- Protection against the financial impact of death or ill health, and for saving
- May be sold to individuals or on a group basis
List the 4 main investment types for life insurance contracts
- Without-profit
- With-profit
- Unit-linked
- Index-linked
Without-profit contracts
A life insurance contract is without profit if the life insurance company has no discretion over the amount of benefit payable, i.e. the policy document will specify at outset either the amount of the benefits under the contract or how they will be calculated.
The key feature, therefore, of without-profit business is its guaranteed, non-discretionary nature.
Without-profit contracts tend to be most appropriate when the primary customer need is protection.
Broadly, this certainly means less risk for the policyholder than on a with-profit or unit-linked contract.
With-profit contracts
A life insurance contract is with profit if the policyholder is entitled to receive part of the surplus of the company or of a sub-fund within the company.
The extent of the entitlement is usually at the discretion of the company.
These contracts tend to be most appropriate when the customer need that the contract is addressing is saving.
It is typical for a with-profit contract to involve some guaranteed benefits and some discretionary.
The factors that come into play, when setting 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 by the company
* Looking at what competitors are doing
* Adhering to regulatory limits on payouts.
Unit-linked contracts
Unit-linked contracts are unitised contracts whose value of units is directly attributable to the underlying value of the invested assets.
Any of the types of contract can be written in a unit-linked form, although normally only contracts with a significant investment element are written in this way.
A unit-linked contract enables consumers either to obtain a higher expected level of benefit for a given premium or to pay a lower expected level of premium for a given level of benefit, than under a comparable non-linked version of the contract. This occurs because the consumer accepts a significant element of risk, mostly investment risk.
In addition, a unit-linked contract can offer flexibility in the types and levels of cover included and the ability to vary premiums according to need.
Index-linked contracts
An index-linked contract enables the consumer to obtain a benefit that is guaranteed to move in line with the performance of an index specified in the contract. Normally the index will be an investment or economic one. Premiums may move in line with the same index, or may be fixed in monetary terms.
How are profits calculated 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
- Increase in the cost of capital
- Tax
= Profit
Assumptions needed to project forward profits in each future year for a life insurer
- Premium rates per policy
- Sales volumes and mix of business
- Investment returns, e.g. bond yields, dividend yields and growth
- Expense levels
- Expense inflation
- Commission rates
- Mortality rates
- Morbidity rates
- Withdrawal rates
- Separate assumptions to calculate the provisions (these assumptions may be more prudent than those used above), for example, a valuation interest rate, valuation mortality rates, etc.
- Solvency capital requirements
- Tax rates
- Reinsurance premium rates and recovery rates
Reasons why a life insurer needs capital
- To cover unexpected events
- To give investment freedom
- To demonstrate financial strength
- For opportunities
- To smooth dividends / bonusses
- For development expenses
- To cover guarantees
Key risks for life insurance contracts
- Mortality, longevity and morbidity
- Investment risks
- Expenses not met by premium loadings or charges
- Early withdrawals, before initial expenses are 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
- Operational risks
List 15 life insurance products
- Term assurance (level)
- Term assurance (decreasing)
- Term assurance (renewable)
- Term assurance (convertible)
- Endowment assurance
- Pure endowment
- Whole life assurance
- Critical illness
- Long-term care
- Income protection
- Immediate annuities
- Deferred annuities
- Income drawdown
- Investment bond
- Keyperson cover
Pure endowment and endowment assurance
- Pure endowment provides a benefit on survival to a known date and hence operates as a savings vehicle
- Endowment assurance also provides significant benefit on the death of the life insured, operates as a vehicle of dependent protection
A group endowment assurance would enable, for example, an employer to provide benefits at retirement, and maybe also on death in service, in respect of their employees
Whole life assurance
A whole life assurance will provide a benefit on the death of the life insured whenever that might occur.
It is a general purpose contract for providing long-term protection to dependants.
There would not seem to be a consumer need for a group version of this contract, since group contracts are usually funded by employers for their employees. It is therefore natural to restrict life cover to the period of employment, rather than offer it on a whole life basis.
Term assurance
A term assurance provides a benefit on a death of the life assured, provided it occurs within the term selected at outset. Since they do not pay benefits on maturity, they are considerably cheaper.
The group equivalent of the term assurance contract can be used by an employer to provide a benefit to dependants on the death, while in employment, of an employee.
Any supplier of goods with payment in instalments could use a term assurance to cover the risk that recovered goods are less valuable than the outstanding loan balances due on death.
Convertible or renewable term assurance
A renewable term assurance is a term assurance with the option to renew at the end of the original contract. The appeal of this option is that the renewal can be made without further medical underwriting.
A convertible term assurance allows the policyholder to convert the term assurance into another type of contract, such as whole life or endowment assurance.
For individuals, these contracts combine the attractions of a term assurance, in terms of obtaining cheap death cover, with the certainty of being able either to convert to a permanent form of contract, i.e. an endowment or whole life assurance, when it can be afforded, or to renew the original contract for a further period of years, all without health evidence being provided.
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.
Immediate annuity
A single premium purchases the income, which commences immediately after purchase.
Immediate annuities meet a financial need for an income for the remainder of the life of the insured, for example, after their retirement.
A group version of the contract can be used by an employer to fund for pensions for employees at or after retirement.
Deferred annuity
Deferred annuities can be used when there is time between the date of purchase and the date when the income stream is required to start.
The contract enables individuals to build up a pension that becomes payable on retirement from gainful employment.
The group equivalent of a deferred annuity can be used by an employer to fund for pensions for employees.
Income drawdown
Under such an arrangement, instead of buying an annuity the fund remains invested and the member withdraws an amount of the fund each year.
There may be legislative restrictions on the:
* amount of the fund that can be withdrawn each year
* age at which drawdown must cease and a pension must be purchased
One of the main drivers behind the income drawdown approach is that, should the member die before having to secure an annuity, the member’s heirs can inherit the balance of the fund.
The income drawdown product will be sold to individuals as a way of meeting their retirement needs.
List the risks involved for the member of an income drawdown contract
- 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.
Investment bonds
These are single premium contracts, normally whole life, designed to enable policyholders to invest for the medium to long term.
A policyholder can usually make withdrawals from an investment bond, however, these may incur a penalty in the first few years of the bond.
Investment bonds can be used in a similar way to investment drawdown products.
Investment bonds are purchased by individuals
Income protection
The contract enables individuals to provide an income for themselves and their dependants in the event of the insured risk occurring. The most common insured risk is long-term sickness or incapacity due to accident or illness.
These contracts typically terminate at retirement age, and do not provide benefits for the first period of any claim. In the first period of a claim, it is assumed that the insured will have other resources.
The group equivalent can be used by an employer to provide a sick pay scheme for employees.
Critical illness
The contract provides a cash sum on the diagnosis of a “critical” illness, such as heart attacks, strokes or many forms of cancer, which could be used for nursing and other care.
The benefits may be offered in “stand-alone” form, where the contract covers only critical illness. In the stand-alone contract, no benefit is paid on death.
Alternatively, the benefit may be offered as a “rider” benefit on another contract.
A group version of the stand-alone contract could be used by an employer to provide financial security for employees in the event of contracting a critical illness.
Key person cover
A life and / or critical illness policy taken out to cover the life of a key person within a business.
This lump sum can be used to:
* buy out the individual from the partnership
* cover any loss of profits as a result of the loss of the key person
* meet the costs of finding a replacement.
The benefit payable may be based on loss of profits to the business, or related to the salary of the key person (to facilitate recruitment of a successor).
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 covering many employees.
Long-term care
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, i.e. post-retirement.
The contract could pay for all the costs of care throughout the remainder of life, or could provide a cash lump sum, or an annuity, to contribute towards the costs of care.
A group version of the contract would enable an employer to provide long-term care cover to employees and their spouses and parents.
