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• UNIT LINKED PRODUCTS – a policy where the benefits are linked directly to the investment performance of a specified fund and characterized by a lower level of guarantees on benefits and premiums • INDEX-LINKED – a policy where the benefits are linked .INTRODUCTION The main structural basis of products • CONVENTIONAL WITHOUT PROFITS – characterized by fully guaranteed benefits and usually level regular premiums • WITH-PROFITS – a policy where the policyholder has an entitlement to part or all of any future surplus which arises under the contract.

and the risks of the product. to the policyholder • The amount of flexibility that is possible in the product design • The risk of the product to the insurance company.INTRODUCTION The type of basis used for a product has important implications for • The cost of the product. including capital requirements and the potential for profit .

INTRODUCTION The Capital Requirement will depend on: • The design of the contract • The frequency of payment of the premium • The relationship between the pricing and supervisory reserving bases • The level of the initial expenses .

INTRODUCTION Initial Capital Strain : the combination of the initial cash outflow. the need to hold prudent reserves and the need to establish a required solvency margin means that money has to be found initially in order to write the business. .

INTRODUCTION Formula: Where . after the first premium has been paid and all the initial expenses . C0+ = Capital Strain at time V0+ = Supervisory reserves and minimum solvency margin at time 0+ E0+ = Expenses and commission incurred by time 0+ P0+ = Premium paid by time 0+ Time 0+ is the point immediately after the policy has been issued.

OPERATIONS OF FUND Figure1. Illustrations on how a nonprofit fund operates. .

all other things being equal.The Risks Involved The main risks relating to these contracts involve: • Investment Returns .The benefit is guaranteed.Expense risk in that the actual marginal costs of administering the contract need to be met. and so if the achieved investment returns are lower than allowed for in the premiums then the insurance company will make a loss. or because of lower than expected sales of business. • Expenses . . for example because of higher than expected price inflation. The marginal costs of a contract are those costs which are incurred because the policy exists. Expenses might prove higher than expected for many reasons.

When the asset share is negative (most likely to be negative in the first few months or years of a regular premium contract. (Including anti-selection risk) A mortality risk may also arise from selective withdrawals. At other times. but this will reduce as duration in force increases. whether there is such a risk depends on how any withdrawal benefit paid compares with the asset share. . The policyholders most likely to withdraw from the contract are those in good health. leaving the insurance company with a sub-standard group of lives.The Risks Involved • Withdrawals . there is a financial risk from withdrawal. because of high initial expenses). • Mortality – there will be a significant mortality risk at the start of the contract.

This issue therefore interacts with the issue of how supervisory reserves are calculated. . • Premium Payment Frequency o For non-participating contract. is whether the design enables reserves and solvency margin requirements to be kept low. the lower the initial capital requirement. the faster any invested capital is released.Capital Requirement The capital requirements of the business depend crucially on: • Contract Design o The key issue in contract design. The slower the increase in reserves over the contract’s term. Regular annual premium. Single premium (least capital needed). o The lower the initial reserves. the following is the order of the capital required: Regular monthly premium (most capital needed).

the more capital is needed.Capital Requirement The capital requirements of the business depend crucially on: • Relationship between the Pricing and Supervisory Reserving Bases o If the reserving basis is stronger than the pricing basis then the premium charged will seem insufficient. to meet the expenses and the benefit. • Level of Initial Expenses. on the reserving basis. they are often stronger than the pricing basis. The stronger the reserving basis compared with the pricing basis. then clearly this will increase . and this is a significant contributor to the total capital requirement. Capital will therefore be needed to set up the required reserves at outset. o The higher the level of initial expenses the less the initial asset share will be. If nothing else changes. Since supervisory reserves have to be prudent.

especially if the company has little relevant data. or related contracts. Industry data and reinsurers’ data may be useful. This will allow appropriate adjustment to be made to standard tables. Allowance should be made for any expected changes. • The expected future experience of the policyholders will depend crucially on three things: o the target market for the contract – this will be dependent on the distribution channel involved o the underwriting controls applied (or not applied) o the expected change in the experience since the time of the last historical investigation to the point in time at which the assumption will on average apply (typically you would be looking about ten to .Setting Assumptions for Pricing Demographic Assumptions (relates to mortality rates) • The actuary will consider the company’s recent experience of the contract.

the extent of investment guarantees. in the absence of suitable data. Withdrawals • The assumption will take as a start point the most recent investigation for that contract or related contracts. Margins • Is required to reduce the financial impact on the company of adverse experience and provide a suitable return to the providers of capital . the importance of reinvestment and the intended asset mix for the contract. or. The impact of taxation must be considered. industry statistics.Setting Assumptions for Pricing Investment return • This will be set bearing in mind the significance of reserves for the contract.

or similar) •  investment •  withdrawal / paid-up expenses •  claim / maturity administration (often known as termination expenses). Expense inflation • This will depend on expected future earnings inflation.Setting Assumptions for Pricing Expenses and commission Need to reflect the incidence of the following marginal expenses: •  initial acquisition (eg initial commission and related sales costs) •  initial medical underwriting •  initial administration •  renewal administration •  renewal reward to sales channel (ie renewal commission. . It must be consistent with the investment return assumption.

that is to the with-profits policyholders and/or shareholders. The liabilities of the life office can be defined as • The obligations that the company has under the contracts currently in force to pay benefits according to the term of those contracts. as appropriate . • The expenses that the life office will incur in the future in order to administer the contracts of insurance it holds. allowing for future premium income and for the anticipated returns from investment.Reserving and Profit Recognition Reserve The amount of assets that the life office needs to hold at a particular point in time (the valuation date) such that. • The obligation to provide a return to those with a stake in the company for the capital that they have provided. the liabilities of the life office will be met as they fall due.

Case Study 1 .

Ct – the total premium income. investment income.000 identical policies are issued at time t=0 • The actual experience is exactly the same as that expected according to the premium basis. It . Et . Ft – the assets (fund) accumulated by the beginning of year t and Pt . while all claims are assumed to be paid at the end of each year • 10. • The accumulation of the fund is described by the following formula Ft+1 = Ft + Pt + It – Et – Ct Where.Case Study Assumptions: • *Premium excluding profit margin (best estimate premium) • All expenses are assumed to occur at the beginning of each respective policy year. expenses and claim outgo incurred during year t .

Case Study The premium excluding profit margin = RM377. .6 Fill in the blank and produce the solutions by using excel.3 Total premium = RM405.