Subject CA1 Paper 2 April 2010 Question 6

Transcription

1 ActEd Acronym App Question 1 Page 1 Subject CA1 Paper 2 April 2010 Question 6 Question An insurance company has been selling term assurance and annuities for over 25 years. Discuss the features of the external environment that affect these two products, highlighting any significant differences. [16] Solution There is an acronym that can be used to help remember the key ideas relating to the external environment (CREATE GREAT LISTS): Commercial issues such as competition and the underwriting cycle Regulation and legislation Environmental issues Accounting standards Tax Economic issues such as interest rates, inflation, growth and exchange rates Governance Risk management requirements Experience from overseas Adequacy of capital Trends demographic Lifestyle considerations Institutional structure (eg mutual or proprietary) Social trends Technology State benefits The Actuarial Education Company IFE: 2015 Examinations

2 Page 2 ActEd Acronym App Question 1 This contains all the key ideas that you need in order to be able to score well, however you should always be careful with the use of acronyms. Students that simply reproduce the acronym will not earn many marks. In order to score well, you should: ensure that you are giving an adequate level of detail for each idea ensure that you bring in the specifics of the question, in particular: the products sold term assurances and annuities the fact that the insurer has been selling these products for 25 years. try to structure your answer in approximate level of importance to convince the examiner that you are thinking about the situation given and not blindly reproducing an acronym. It might be useful to jot down some key features of these two products and the risks taken on in selling them. Legislation and regulation Legislation may require the purchase of annuities to be made compulsory in certain circumstances. For example, in some countries, individuals are only allowed to take a small proportion of their retirement savings as a cash lump sum and the rest must be used to purchase an annuity. Regulations may influence the rating factors that may be used in pricing (for instance a requirement to use unisex annuity rates), which could lead to anti-selection against the insurer this may lead to insurers taking a more cautious approach to pricing, or to avoid selling certain products. In addition, the sales process might be regulated. Economic factors The economic outlook will have a significant impact on the sales of both products, for example; in good economic conditions, an individual may have more money to plan for early retirement and so purchase an annuity in a recession there may be higher lapse rates for term assurances if individuals feel they cannot keep up the premiums and have more pressing immediate needs IFE: 2015 Examinations The Actuarial Education Company

3 ActEd Acronym App Question 1 Page 3 State benefits There may be State benefits available, for example: a State pension, which would reduce demand for annuities (or reduce the average size of annuities sold) may be a disincentive for individuals to save death benefits paid to dependants, which would reduce demand for term assurance business. Tax Tax might affect: the level and/or form of benefits desired by customers eg annuity sizes will be smaller if a tax-free cash sum is taken from them the attractiveness of products eg term assurances will be less attractive if the lump sum payout is subject to tax the price charged for products eg if insurance companies premiums, profits or investment returns are taxed, then this is likely to be reflected in the price. Demographic changes Increasing longevity will increase the number of payments made under an annuity and hence the cost of providing the benefits. This can be corrected by increasing premiums for new business (assuming competitors follow suit), but not for existing business, which may become loss-making. Increasing longevity will also reduce the likelihood of a payment being made under term assurance business, and so lead to a reduction in premiums and/or an increase in profits. Capital adequacy and solvency The amount of capital required will have an impact on the prices charged for the two products. In particular, term assurance products only make a payout in the (more unlikely) event that the individual dies within the term. In contrast, for annuities, capital will need to be set aside to make payments throughout the individual s expected lifetime as a result, capital requirements for term assurance products are typically much lower than for annuity business. The Actuarial Education Company IFE: 2015 Examinations

4 Page 4 ActEd Acronym App Question 1 Any guarantees offered will further increase the amount of capital required for example, the insurer may have offered guaranteed annuity rates in the past that now appear attractive, or the annuity may be guaranteed to be paid for a certain period (eg payments continue for 5 years even if the individual dies in that period). As the insurer has been selling these products for over 25 years, capital requirements associated with new products (eg product development costs) will be relatively low. The need for capital adequacy forms part of banking and insurance regulation and is carried out using a capital adequacy framework. This is Solvency II for insurers. Accounting standards Accounting standards are likely to require provisions to be held in respect of future claims. If provisions need only be held on a best estimate basis, the requirements may not be very onerous. However, if the provisions that need to be held in the insurer s accounts are too great, insurers may be deterred from selling the product this is more likely to be a bigger issue for annuity business than for term assurance contracts, as the reserves held will be larger. Corporate governance This encourages managers to act in the best interests of stakeholders and incentivises managers accordingly. Risk management requirements Risk management requirements are concerned with measuring, monitoring and controlling the impact of risks on a firm s balance sheet and can be categorised using the Solvency II framework. Risks relating to investment (market risk and credit risk) and underestimating life expectancy will be particularly important for annuities business. Overestimating life expectancy will be particularly important for term assurance business. IFE: 2015 Examinations The Actuarial Education Company

5 ActEd Acronym App Question 1 Page 5 Corporate (institutional) structure The corporate structure of the business will impact on its ability to raise finance and sell capital intensive products. Since annuity products are more capital intensive, these may be less attractive for mutuals which can t readily raise finance by the usual methods. Commercial considerations The position in the underwriting cycle is an important consideration when making strategic decisions. It may be that the two products are at different points in the cycle at any given point in time. Changing social trends Changing social trends might have an impact on the demand for insurance products and the experience of the insurer. Although the insurer has been in operation for over 25 years, past experience may be of limited use when pricing annuities and term assurances in the future. For example: an increase in the amount of publicity on the negative impact smoking has on health could reduce the number of smokers, which may increase the number of payouts under an annuity contract (leading to an increase in the cost of annuities) and reduce the number term assurance claims (leading to a reduction in the cost of term assurance products) an increase in home ownership could lead to a greater demand for term assurance products (especially if this is required by the mortgage lender) a reduction in the provision of State healthcare could lead to heavier mortality, which will reduce the number of payouts under an annuity contract and increase the number of term assurance claims an increase in individuals spare income could lead to an increased demand for savings products, eg deferred annuities. Lifestyle considerations Changes in lifestyle, eg increased awareness over the importance of diet and exercise may also change life expectancy. There may also be moral hazard, for example, individuals who have taken out a term assurance product may be more likely to take up smoking or start smoking again. The Actuarial Education Company IFE: 2015 Examinations

6 Page 6 ActEd Acronym App Question 1 Environmental issues Concerns over the environment and global welfare have led to providers offering products that promote environmental and ethical issues. For example, such concerns may affect how providers communicate with customers, eg reducing the amount of paperwork. International practice An insurance company who has been selling annuity and term assurance contracts for over 25 years may well have exhausted all the ideas that have arisen in the domestic market. The company wish to: look to overseas companies for new attractive features of annuity and term assurance contracts that could increase the marketability of its existing products replicate successful overseas products in the domestic market, subject to tax and legislative considerations. Technological changes Increased use of the internet might impact the sale of insurance products, such as term assurances. Improvements in technology could also improve the underwriting and claims control processes, as well as making it easier to maintain good quality data. IFE: 2015 Examinations The Actuarial Education Company