SP2 April 2023 Examination

Answers

Answer 1.

1. Smoothing is a fundamental feature of with profits business because the benefits have discretionary
element of bonus declaration, and it has to be fair and consistent across all the policyholders.
2. With-profits business have higher exposure to volatile business (equity or properties) to achieve higher
returns based on policyholder expectation.
3. Smoothing helps in average the surrender payout by keeping the policyholders’ expectations realistic.
4. If smoothing isn’t applied, then any higher returns achieved will need to be shared with the policyholder
which will further increase the expectation in futures for other individuals.
5. But in case, if market doesn’t perform consistently then there will be reputational damage to the insurer if
they are not able to hold the same surrender value in future as well.
6. Similarly, if the returns are lower than expected then without smoothing, policyholders will be dissatisfied
and will have an impact on company’s reputation.
7. Therefore, smoothing is important on asset share to provide reasonable returns to the policyholders. This
way, insurer provides higher surrender value in case of poor investment performance to meet the PRE
and in case of high investment performance, they provide reduced surrender value to keep realistic
expectations in future.
8. The product literature and policy documentation should refer to smoothing practices.
9. Smoothing helps to minimize the subjective judgement.
Answer 2.

(i)

1. Data at previous investigation + New business – business gone off books = Data at current investigation
a. Applying this check on number of contracts:
65000 + 2040 – 3620 – 250 – 600 = 62570
Which is consistent with reported figures.

b. Applying this check on total sum assured:

8125 + 296 – 1629 – 38 – 69 = 6685
Which is inconsistent with reported figures.

c. Applying this check on total premium:

3.9 + 0.14 – 0.16 – 0.02 – 0.04 = 3.82
Which is inconsistent with reported figures.

2. Checking the average ratios between sum assured and number of contracts:
a. For previous investigation
$8125m / 65000 = $125000 per policy
b. For current investigation
$7770m / 62570 = $124000 per policy approx.

3. Checking the ratio of sum assured to annual premium:

a. For previous investigation
8125/3.9 = $2083
b. For current investigation
7770/4.19 = $1854

4. Checking the average ratio of annual premium and number of contracts:

a. For previous investigation
$3.9m/65000 = $60 per policy
b. For current investigation
$4.19/62570 = $66.97 per policy

(ii)

1. Reconciliation of number of contract is matching with our validation.

2. Sum assured and annual premiums are inconsistent with the reported data, which highlights the
possibility of data corruption for new business or policy terminations.
3. The average of sum assured is consistent between both the investigations which seems reasonable.
4. However, the average of per policy premium is higher for current investigation by $6.97 compared with
previous investigation.
5. It means that policyholders are paying increased premium for the same level of sum assured which isn’t in
line with reasonable policyholder expectation.
6. Though this could be due to revised premium basis (due to higher expenses or change in experience)
7. Company should still investigate the cause of difference and correct the data accordingly.
8. Ratio of sum assured to premiums are also not consistent which is expected due to major difference in
premium rates.
9. Company should validate the source of data and check for any typos or mathematical errors in base
calculations.
Answer 3.

1. There might be competitive disadvantage if the competitors are still using old rates and threaten the
position of the insurer.
2. This will be unfair to the surrendered policyholders and may result in reputational damage. There may be
more law suits against the company under this practice.
3. By increasing the surrender payouts, there may be risk of not matching the benefit with asset share.
4. If asset share is lower than surrender value then there will be huge losses to the company.
5. There may be regulatory restrictions against the company’s planned approach which may limit its options
and may create more operational challenges.
6. This may further increase the solvency requirement for the company.
7. Company might be changing the approach of calculations frequently which may not be appreciated by
customers due to ambiguity, confusing. Company will also incur higher expenses due to the same.
Frequent documentation update will be required with clear and appropriate wordings.
8. Company needs to match maturity value near the end of the policy term to maintain equity.
9. Company needs to match the premiums paid in initial duration to maintain the equity.
10. With higher surrender value, company is at higher risk of laps and surrender.
11. Profit between surrendered policies should match with continuing policyholders.
12. The new approach should be easy to calculate if it isn’t.
13. It should avoid for any discontinuities.
Answer 4.

(i)

Adding an illiquidity premium increases the risk-discount rate which reduces the overall liability for the company
and improves the solvency position.

(ii)

1. Illiquidity premiums are added to the corporate bonds due to the time lag in the liquidity of these assets.
2. Since the benefits of annuity products are backed by corporate bonds, they are eligible for this
adjustment.
3. If the annuity benefits are matched by appropriate term then there is no risk from price volatility to the
insurer as the bonds will match the maturity period.
4. So, the returns from illiquidity premiums are beneficial for the company since they are not exposed to
liquidity terms.
5. This adjustment is applicable to long term predictable liabilities for which matching assets can be held to
maturity.
6. Since the other business is more volatile due to the withdrawal risk, so there is a reduced chance of
applying illiquidity premium to other class.
7. However, the company is still exposed to the price volatility risk for annuity business in case bonds default
so they still need to allow for this risk appropriately within the risk discount rate.
8. There will be additional regulatory requirement on the application of illiquidity premium which ever
company needs to adhere to.
9. Regulation may specify which contracts can allow for this adjustment and to which extent which needs to
be carefully followed by each insurance company.

(iii)

1. Illiquidity premium would be allowed on corporate bonds.

2. Since corporate bonds have higher default risk and liquidity risk than risk-free bonds (eg government
bonds).
3. So, regulation only dictates the application of this adjustment on corporate bonds.
4. This adjustment is applied to the yield of the assets.
Answer 6.

(i)

Company A may be increasing its risk premium rates due to following reasons:

1. There may be increase in the overall risks shared by the reinsurance company.
2. Mortality risk of the reinsured population may have worsened due to change in lifestyle or any
widespread of illness.
3. Credit risk of the reinsured business might have deteriorated, increasing the default risk and therefore,
the increase in risk for reinsurance company.
4. There may be change in regulations impacting the premium rates to increase.
5. Regulation may require higher solvency requirement, restricting company’s financial resources. Therefore,
company has to charge higher premiums to maintain the cashflow.
6. There may be increase in expenses making the premiums more expensive than before.
7. Investment returns may be lower than expected, causing losses to the reinsurance company and need to
charge higher premium rates on existing and new business.
8. There may be general increase in premium rates due to higher inflation industry wide.
9. New business volume might have reduced for the company, increase the per policy expense and making
the premiums expensive than before.
10. There might be change in legal or tax laws not in favor of reinsurance companies and hence making it
more expensive.
11. Company might have changed the assumption approach from best estimate to prudence due to change in
target market which might have increased the premium rates.

(ii)

Possible actions taken by company B in response to company A’s actions:

1. Company B could try to negotiate the increased rates with company A based on their pre-established
relationship.
2. Company B can try to change the terms of cover such as opting for individual surplus instead of quota
share arrangement.
3. The amount of cover can also be reduced to lower the risk of reinsurance and hence lowering the
premium rates.
4. Since risk premium approach is independent of the premiums charged to policyholders, company B can
revise its original premiums to cover for additional expense.
5. This would lead to revision in pricing assumptions and revised premium rates.
6. However, there may be limited extent for this action due to competitive reasons. Market premium for
term assurance businesses are usually low so company B may need to maintain that.
7. Company B can also try to market its existing product to increase the volume and offset the cost of
additional reinsurance premium charged.
8. This might help the company to lower its per policy expenses as well and make the policy more attractive.
9. Company B could further look at the quotes from other reinsurance companies to find competitive rates if
available.
10. Company B can also try to reduce its mortality risk by stringent underwriting which would reduce the
overall risk for reinsurance company as well.
11. This might help to renegotiate the terms with the reinsurer.
12. Company B can try to look for different reinsurance arrangement such as original terms, catastrophe or
excess of loss for its term assurance business which may not have any impact on premium rates.
13. Company B can opt for no reinsurance if it has sufficient reserves and funds to reduce its risks. This would
also help company B to retain more profit and help in recovering the expenses faster.
14. This will reduce the overall expenses for the company.
15. Company may also plan to set aside mortality fluctuation reserve instead of reinsurance.
16. Company can also change its pricing basis if it has sufficient business experience from prudent to best
estimate to lower the original premium rates and then allow for reinsurance.
17. This may depend on company’s risk appetite and financial situation.
Answer 7.

(i)

Suitability of potential group products for the company to offer:

1. Whole life assurance –

a. If the company expects its employees to stay with them for a long period of time which may
exceed the term under different products, so company may wish to take group version of whole
life product.
b. However, whole life products will be costlier than term products. This will increase the group
cover for the employee.
c. Whole life assurance may have more benefits such as benefits on surrender or maturity. If any
employee decides to leave the organization, then the employer may take the surrender benefit
for themselves to recoup the costs associated with the insurance cover.
d. Employer may have a great employee relationship and wish to insure the lives for a longer
period. This may give positive publicity to the company and may motivate employees to stay
longer with the company.

2. Term assurance –
a. Group cover is usually provided for term assurance products covering the risk of death of the
employee. This is the most popular version under group type.
b. These policies are more affordable and impose lesser financial strain on the employers.
c. It provides sufficient cover to the employee’s family in case of any unfortunate event and helps
the employer to meet the regulatory requirements at minimum cost.
d. However, if the competitors are providing higher benefits, then the company may remain at risk
with the basic plan as term assurance.
e. The term of this cover will restrict to the period of employment.
f. Company may wish to take one-year renewable group term assurance to avoid the risk of mobile
workforce.
g. This policy type is more convenient to administer and have lower costs.

3. Convertible term assurance –

a. This type of contract is not usually a choice of employers while taking out group cover.
b. However, this policy may provide an option to the employee to continue the policy by converting
to individual whole life or endowment.
c. This may seem more suitable to the employees who do have not any backing insurance policy
and with the change of employment, they might want to keep the cover as it is.
d. Surrender values are not usually paid before the conversion during the group life.

(ii)

Risks to the life insurance company under group term assurance:

1. Mortality risks –
a. Majority of the population under the grouped version of this contract will be the drivers who will
have greater risk of accidental deaths due to increase in case of road rage.
b. There will also be increase in mortality risk for drivers due to poor lifestyle.
 c. All the employees of the company (executive staff, administrative staff and drivers) will be
covered under the similar premium rates despite the difference in mortality experience.
d. There will be increased risk of anti-selection since policy is not compulsory but optional.
Individuals with higher risk such as drivers may opt-in the option to take the insurance instead of
executive staff who may already have a parallel insurance in place.
e. This will increase the mortality risk for the company.
f. Depending on the policy size and reserves accumulation, there will be death strain. If the
reserves accumulated are lower and there will be high death strain due to guaranteed sum
assured based on basic salary.

2. Expense risks –
a. Actual expenses may be higher than expected.
b. Expense inflation may be higher than expected.
c. The maintenance of group contract may be higher than expected.
d. If less population avails the option to take the insurance cover, then the proportion of overhead
expenses will be covered among less policies, leading to higher per policy expense.

3. Withdrawal risks –
a. If the employee decides to leave the organization, then there may be the risk of selective
withdrawals.
b. Individuals with poor health will plan to remain with the existing employer to avoid taking out
the insurance from any other competitor at higher rates.
c. So, there will be higher risk of selective withdrawal.

4. Aggregation and concentration of risks –

a. There will be increased concentration risk in case of any group specific event such as collapsing of
headquarters or spread of infectious disease in the organization.
b. This will increase the risk for the company.

5. Other risks -
a. There may be higher risk of fraudulent claims.
b. There may not be enough experience available to correctly price the product.
c. Competitors may provide better rates to the company.
d. Inflation may be higher than expected, eroding the benefit value for the employees and resulting
in reputational damage.
e. Delay in claim settlement which may further impact the reputation of the company.
f. Counterparty risks if premiums are not received from the company in early duration of the
product issuance, causing loss to the company due to higher initial expenses.

(iii)

1. Insurer may wish to sell this product due to higher profit margins available.
2. insurer may have expertise in such products and expects to accurately price the product to maximize the
profits and gains.
3. Insurer may have monopoly in the market for this product and may exploit the same to charge higher
from the company.
4. Insurer may wish to make profits from the cross subsidies between large size policy (for executive staff)
and small policy size (for drivers).
(iv)

1. Insurer may allow for any loading within the premium rates to account for anti-selection.
2. Insurer could allow appropriate loading for different risks associated with age, size of sum assured, gender
or smoker/non-smoker status.
3. This may result in higher premium than expected.
4. There may be higher level of prudence in the assumptions.
5. Insurer may decide to use risk discount rate with appropriate risk margin.
6. Company can also use cost of capital rates to allow for appropriate risk measure.
Answer 8.

(i)

Company is planning to sell through direct marketing via own website.

Risks in selling through new distribution channel:

1. The risk profile of the company and experience will change for the term business written through the new
approach.
2. The changes will become much significant as the proportion of business written through the revised
distribution approach increases compared to the overall business.
3. The company’s target market will change since there will be lack of advice during the sales of term
product.
4. This may lead to target market being less financially sophisticated.
5. Usually, direct marketing targets those with lower level of income so the mix of new business may change
substantially for the company.
6. The level of underwriting is likely to reduce and simplified compared to those for insurance
intermediaries. However, it exposes the company to higher risk of non-disclosure.
7. Customers may not disclose all the required information under online mode to reduce the premium rates
which will increase the risk of anti-selection for the company.
8. Policyholders will be accepted more on standard rates when they should be declined. This would further
increase the risk for the company which will be a major risk for term business to the insurer.
9. Due to the lack of experience with new channel, company may not be able to correctly use the pricing
assumptions. It may lead to lower profits or even loss making in certain situations.
10. Company will also need to account for additional mortality risks due to the change in target market and
underwriting level. The mortality experience would be expected to be heavier than for the lives under
independent intermediaries.
11. There is an additional risk of incorrectly estimating new business volume and mix.
12. With the introduction of new channel, the expenses for the company will increase due to development
cost of the website which will be divided among the new business policies. If the volume is lower than
expected, then per policy expense would increase making it more expensive.
13. This will introduce competitive risk to the company if the prices are higher than the competitors.
14. If the company uses higher margin than they should due to unavailability of experience, it will also
increase the competitive risk for the insurer.
15. Policyholders will now be able to compare the different policies through online sites with all the product
information available on the website. This will also be a major competitive risk to the insurer.
16. Regulatory risk exposure may change in direct marketing if there is any associated restrictions on the sale
of policy or reserving requirement.
17. There will be greater operational risks due to changes made to company’s system.
18. If the user interface of website isn’t convenient or is unable to handle the policyholder traffic resulting in
frequent crashes. It will have a great reputational damage for company. So, insurer will need to maintain
quality of its IT department.

(ii)

Factors to be considered for pricing assumption update:

1. Mortality assumption –
 a. With the change in target market to less financially sophisticated customers, company will need
to allow for appropriate margins in its assumptions.
b. Also, company will need to account for any reduction in the underwriting which may increase
anti-selection risks for the company.
c. Insurer may expect the mortality experience to be heavier for the new policies under direct
marketing due to above listed reasons.
d. For term policies, mortality is the most important assumption so company will need to account
for relevant margins and calculation.

2. Persistency assumption –
a. The level of lapses or surrenders under the new channel are likely to be different.
b. It may be worse due to lack of advice during the sales process. Policyholders may purchase
unnecessary policy or incorrect product which may not meet their needs. However, since this is a
simple term product, the risk of mis-purchasing might be low.
c. Under the new channel, policyholders will be initiating the sales so there may be less chances of
lapsing the policy as compared to insurance intermediaries.
d. Since most of the policy size is expected to be smaller and affordable, it will reduce the
circumstances of unaffordability and may improve the experience.
e. However, persistency may worsen if the level of underwriting is reduced.

3. Expenses –
a. There is likely to be higher expense in short term due to associated development costs,
administrative needs or the setup of IT department for the company.
b. However, in the long term expenses would be expected to be lower than for the intermediaries.
c. Per policy expense will also differ due to the change in persistency and mortality experience.
d. The smaller policy size will mean that fixed expenses will be a higher proportion of the per policy
expense.
e. The expense may reduce for the company if they plan to cease the channel of intermediaries and
saving the commission costs.
f. This may offset the initial expense of setting up a new channel with the initial commissions
offered to the intermediaries.
g. There may be regular IT maintenance cost added to the renewal expenses for the company.
h. There may also increased expenses of marketing or advertisement of the new website launch of
the company which will be added to the fixed expenses.
i. There will be higher expense associated with revision of product literature and setting up
sufficient administrative structure.
j. Company may wish to set up more resources to follow up on the sales under new channel to
maintain appropriate post sales relationship with the clients and reduce its overall risks of lapses.

4. New business volume -

a. The expected new business volume will change under the new channel.
b. New business volume may increase if the premiums are competitive compared to other
companies in the market.
c. With the lower expenses in long term, premiums offered through new channel may be more
attractive to the policyholders which may increase the new business volume.
d. However, there may also be a risk of low new business if the rates offered are not as competitive.
If not, then there will be higher per policy expense as well, making the policy more expensive and
unattractive to the policyholder.
 e. New business mix will also differ with the change in target market. There will be more policies
with reduced premium sizes and the same will need to be reflected during the pricing exercise.

5. Reserving –
a. Due to the lack of historical data and uncertainty associated with the new channel, company may
wish to increase the reserves to avoid any financial strain.
b. Company may wish to include sufficient margin in the assumptions to absorb the risks with the
new channel.

6. Solvency capital requirement –

a. There may be additional regulatory requirement under the new approach increasing the solvency
requirement and lowering the free assets with the company. Any restriction or limitation
imposed by the regulation will have a direct impact on company’s profitability.

7. Profitability –
a. Company may wish to introduce profit margin within each of its assumptions to meet the
minimum profitability requirement.
b. They must consider overall impact on profitability.
c. Company may wish to keep minimum profit margin to remain competitive in the market and
increase new business volume which will ultimately increase the profits for the company.

8. Taxation –
a. Any changes in the taxation structure will also need to be considered under the new approach.

9. Expense Inflation –
a. There will not be any impact on inflation assumption between the two distribution models so it
should remain consistent.

10. Investment returns –

a. There will not be any impact on investment assumptions either between the two distribution
models so it should remain consistent unless company decides to revise its investment strategy
due to change in risks and expenses.
b. However, for term business, reserves are relatively small so there will be less impact from change
in investment returns.

Company will have no prior experience on the new channel to use for pricing assumptions so they will have to rely
on industry data or seek assistance from reinsurers to avoid the risk of mispricing.