Chapter 23: Contract design

Question 1

Contract design factors

Answer 1

• PREMIUM / contribution pattern
• MARKETABILITY
• PROFITABILITY
• BENEFITS — level and form

C - CONSISTENCY with other contracts
O - The characteristics of OTHER STAKEHOLDERS involved in contract design
N - customer NEEDS and interests
T —- benefits TAKEN EARLY / discontinuance benefits
R - RISK APPETITE of the parties involved
A - ADMINISTRATION systems
C - COMPETITION
T —- discretionary benefits

F - FINANCING requirements
A - ACCOUNTING implications
C - CHARGES vs expenses
T - contract TERMS and CONDITIONS
O - OPTIONS or guarantees
R - statutory / REGULATORY requirements
S - extent of cross-SUBSIDIES

Question 2

Parties involved in contract design (7)

Answer 2

• client or clients
• client’s customers
• actuaries
• accountants
• lawyers
• administrators
• financial backers

Question 3

3 influences on client’s actual needs

Answer 3

• chosen market
• available capital
• available expertise

Question 4

4 influences on the actual needs of a client’s customers

Answer 4

• capacity to pay
• risks to be covered
• benefit that are needed at different times in the future
• attitude towards financial risk

Question 5

Stakeholders involved in contract design:

- Actuaries

Answer 5

Actuarial will be involved in

• the INITIAL COSTING of the financial structures
• the subsequent determination of the PROVISIONS that will need to be held to meet future liabilities.
• the DESIGN through assessing the impact of both the cost and reserving implications on modifications to the benefit design.

Question 6

Stakeholders involved in contract design:

- Lawyers

Answer 6

Involved in DRAFTING THE CONTRACTS supporting the financial structures

to ensure that the provider is not exposed to the risk of
…. providing more benefits
…. or entering into greater risks
than intended.

Question 7

Stakeholders involved in contract design:

- Accountants

Answer 7

involved in ensuring that the provider of the financial structures PROPERLY ACCOUNTS for their income and outgo.

Question 8

Stakeholders involved in contract design:

- Financial backers

Answer 8

Financial backers will want REGULAR REPORTS demonstrating proper stewardship of the finance provided.

Question 9

Stakeholders involved in contract design:

- Administrators

Answer 9

Need to ADMINISTER the financial structures.

The more complex the financial structures, the greater the cost of administration will be.

Question 10

3 Basis motor insurance is commonly written on

Answer 10

• 3rd party only
• 3rd party, fire and theft
• fully comprehensive

Question 11

Level and form of the benefits to be provided vary according to (3)

Answer 11

• client’s needs
• risks to be covered
• client’s ability to pay

Question 12

Financial products and schemes often contain terms and features that provide options to the client with respect to: (4)

Answer 12

• payment of premiums
• benefits
• use of the contract proceeds
• other items

Question 13

4 Commercial considerations associated with contract design

Answer 13

• profitability
• marketability
• competitiveness
• statutory / regulatory requirements

Question 14

5 important factors that might impinge on the profitability of an insurance contract

Answer 14

• Claims experience
• Expenses & expense inflation
• investment returns
• withdrawal experience
• new business sales volumes and mix

Question 15

4 Elements regarding the profitability element of claims experience

Answer 15

• frequency
• severity
• inflation
• options and guarantees

Question 16

Regulation can affect (5)

Answer 16

• CAPITAL REQUIREMENTS of a contract
• contract DESIGN
• PREMIUM (min or max)
• SALES METHOD used
• level of UNDERWRITING allowed

Question 17

New business strain

Answer 17

New business strain arises because the premium received in the first year may be less than

• sum of the initial expenses,
• initial commission paid
• initial increase in provisions (or reserves)
• and the initial solvency capital requirements.

Question 18

4 methods of financing benefits

Answer 18

• pay-as-you-go
• funding all the benefit in advance
• regular payments building up a fund
• paying an amount when the event happens for example purchasing an annuity at the point of retirement

Question 19

Pay-as-you-go

Answer 19

A situation where the sponsor makes the necessary payments only at the points that each separate tranche of a benefit becomes due.

Question 20

Costs for an insurance company setting up a contract

Answer 20

INITIAL:

• contract design
• advertising/sales
• commission

ADMINISTRATION:

• of setting up new client records
• the ongoing administration of collecting contributions / premiums
• the administration of paying benefits as they fall due

OTHER:

• management of assets
• the profits of the provider
• the overheads of the provider