Key risks
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Investment strategy
Mortality (too many deaths), longevity (living too
long), morbidity (sickness)
Investment risks, e.g. poor or volatile returns, fall in
asset values, default risk
Expenses not met by premium loadings / charges
Early withdrawals, before initial expenses are
recovered
New business volumes, e.g. too high -> new business
strain, too low -> not enough business over which to
spread overheads
Credit risk, e.g. failure of a counterparty such as
reinsurer or broker
Operational risk, e.g. fraud, systems failure, change in
regulation
Underwriting
The process used to determine the level of risk posed by a
potential policyholder.
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Most common:
o medical underwriting: questions on the
insurance application form
o further evidence required if risk is
potentially higher than standard
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medical records
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routine medical exam
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specialist medical tests
Setting premiums and contract design
➔ Use of formula or profit-testing model
Assumptions to project future profit:
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Premium rate per policy
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Sales volumes and mix of business
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Investment returns, e.g. bond yield, dividend yield
and growth
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Expense levels
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Expense inflation
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Commission rates
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Mortality rates
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Morbidity rates
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Withdrawal rates
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Separate assumptions to calculate provisions, e.g.
valuation interest rate, valuation mortality rate
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Tax rates
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Solvency capital requirement
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Reinsurance premiums and recovery rates
Nature, Term,
Currency, Uncertainty
The insurer will need to consider the characteristics of its
liabilities when determining its investment strategy.
➔ Fixed interest bonds: meet L fixed in money terms such as
R1m death benefit
➔ Real assets: meet inflation-related L such as inflationlinked annuity payments, expenses
➔ Equities and property to maximise returns, e.g. to provide
for discretionary benefits such as with-profits bonuses
➔ Assets to match term of L: predominantly medium to long
term, but some short-term for immediate cashflow
requirements, such as benefits in payment
➔ Assets denominated in domestic currency
➔ Some derivatives to hedge against guarantees and
options.
Constrained by:
Regulation (specify what can invest in)
Size of free assets (and freedom to mismatch in
pursuit of higher returns)
Need to be tax efficient
Life Insurance
Other factors to consider in contract design:
Meeting customer’s needs
Type of benefits – level, form (income / lump sum),
time of payment, guarantees and options
Competition
Marketability
Simple administration
Financing requirements
Consistency with other products
Monitoring experience
Long term -> important to correct incorrect assumption as soon
as possible to avoid continuing writing business on unprofitable
terms.
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Claim rates: Mortality, morbidity rates
Withdrawal rates
Expenses
Reinsurance premiums and recoveries
Competitor’s premium rates
Investment returns
Sales volumes and mix
Key features
Long term, cover provided for many years (e.g. 20)
One claim, cover ceases on claim
Claim amount may be known with certainty
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Financial Protection: death, illness
Savings
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Individual / group
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Without-profit
With-profits
Unit-linked
Index-linked
Key consideration of contract design is profitability.
Need for capital
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Cover unexpected events, e.g. adverse experience, misselling fine
Give investment freedom: more free assets increases the
ability to mismatch in pursuit of higher returns
Demonstrate financial strength: increase business, better
credit rating
Opportunities: ventures (mergers, acquisitions)
Smooth dividends / bonuses
Development expenses: advertising, marketing, prod dev
Provisioning
Once cover commences, the insurer is required, by regulation,
to establish provisions.
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Basis can be different from pricing basis (more
prudent)
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May also be required to hold minimum level of
solvency capital (to ensure greater security that
benefits are paid)
New business strain and capital
First month
Income: premium
Outgo: initial administration and underwriting
expenses, setting up provisions and minimum capital
requirement
If income < outgo then new business strain
➔ Need for capital
Loss is recouped later:
Premium > expenses
Release of (prudent) reserves and capital > claims