Flashcards in Contract Design and Pricing Deck (12):

1

## What should we think about for suitable design?

###
1. Profit

2. Marketability

3. Customer needs

4. Competitveness

5. Distribution method and remuneration

6. Financing/capital requirements

7. Guarantees and options

8. Sensitvity of profit

9. Extent of x-subsidies

10. Admin systems

11. Service standard

12. Reputation

13. TCF

14. Level of risk

15. Underwriting standard

16. Tax

17. Reinsurance terms and capacity

18. Admissibility of assets (use in valuation)

19. Legal/Regulatory constraints

20. Monitor and review performance and terms regularly

2

## Why is discounted cashflow approach used for pricing over equating present values?

###
1. Only approach to price unit-linked

2. Allow for tax easily

3. Account for term structure of interest rates

4. Easier to have assumptions varying over time e.g. stochastic

5. Reinsurance can be allowed for, including financing

6. G's and O's modelled better

7. Easily allow for withdrawals/PUPs

8. Easily cope with complex charging structures like where charges/benefits depend on future assumptions

9. Explicitly allow for set up of reserves and meeting solvency requirements

10. Can investigate sensitivity of profit to different assumptions easily

11. Allows measuring expected return providers of capital will receive, for WP expected contribution to free assets

12. Use to assess NB financing requirements easily

3

## Why is CWP sometimes priced using equation of value, and when is it more appropriate to be discounted cashflow?

###
1. Equation of value as contracts not finally priced until go off books

2. Not good for proprietary company - doesn't quantify rate of return company hopes to get on sales

4

## What are the main assumptions to think about in the pricing basis?

###
Mortality

Investment return

Expenses

Persistency

Tax

Risk discount rate

Profitability target

5

## What needs to be considered in terms of mortality for pricing?

###
1. Method of finding rates - standard table adjustment/past experience/reinsurer data/cmi data

2. Mortality improvements particularly for annuities

3. Anti-selection including withdrawals

4. Underwriting standard

5. Nature of policyholders targeted

6

## What needs to be considered in terms of persistency in pricing?

###
1. Based off results of experience investigation of this type of contract or one close to it

2. Separate rates for withdrawal/pups may be needed

3. Possibly vary by premium level

7

## What needs to be considered in terms of tax in pricing?

###
1. Appropriate rate e.g. if BLAGAB or not

2. Allow by reducing discounted net cashflow by it

3. Then compare to profit criteria

8

## What needs to be considered in terms of profit criterion in pricing?

###
1. Appropriate target needed

2. May be IRR on initial capital strain

3. May be NPV profit as % of premium

9

## What needs to be considered in terms of expenses in pricing?

###
1. Assumption from recent experience investigation on that type

2. If no recent investigation/unreliable then similar type of contract

3. If 1 and 2 unsuitable, then reinsurer/consultant data if appropriate

4. Overheads and development costs relies on expected volume of new business

5. Allow for future inflation, consistent with investment return

6. Allow for commission at expected rates of that market

10

## What needs to be considered in terms of investment return in pricing?

###
1. Consider matching assets and yields from them

2. Allow for default risk and liquidity risk in corporate bonds vs. govt. bonds (explicit in stochastic)

3. If market consistent pricing, risk free rates probably term dependant to be used

4. Financial guarantees to be priced using option price theory or stochastic modelling

5. Financial guarantee assumptions needed are economic scenarios and correlations between inflation and investment returns

6. Allow for reinvestment risk, stochastic has this explicitly

11

## What needs to be considered in terms of risk discount rate in pricing?

###
1. If traditional pricing, allow for margin above risk free to reflect shareholder required return

2. High margin for high sensitivity/variance in profit

3. Risk free rate based on current term structure of interest rates

4. Market consistent uses risk free discount rate, risk allowed for in experience assumptions of cost of capital method under SII

5. MC approach can lead to greater volatility in price to be charged for given profit criteria

6. So companies could use approach to help understand difference between traditional and MC valuations

7. MC approach gives info consistent with Value added of NB under MCEV

12