X 3.

(i)

Advantages:

- Quicker, cheaper and easier to design, build and run

- Clearer what scenarios have been tested
- Results are easier to explain to a non-technical audience

Disadvantages

- Doesn’t allow for the uncertainty of outcomes

- Doesn't consider the correlations between variables
- Cannot identify extreme outcomes

(ii)

Advantage:

- Mimic closely the key characteristics of the liabilities, eg if they

vary with inflation
- Allow for uncertainty in the key risks
- Enable better modelling of the correlations between variables
eg how withdrawal rates on the class of business vary with
investment returns
- Produce a distribution of results, therefore giving more insight
to the business
- Help the insurer understand the impact of extreme events
- Aid understanding the tail of risk

Disadvantage:

- Time consuming to run the model

- Expensive
- Require expertise to design and run the model
- Require a high level of accuracy and this outweighs the need to
produce the result quickly

(iii)

Stochastic model.

It is suitable for modelling guarantees. Annuity offers a guaranteed

income stream.

It allows the correlations between variables, e.g. investment return,

inflation.
X 3.2

- The target market maybe different, this leads to difference in

policyholders’ morbidity rates
o Occupation
 Occupation determines a person’s environment
for often 40 or more hours per week. Some
occupations are exposed to potential harmful
substances (eg chemicals) or potentially
dangerous situations (eg working at heights)
o Income
 Higher income permits people to adopt a
particular lifestyle, diet housing quality and
access to health care.
o Climate and geographical
 Two insurers may have different markets i.e.
urban vs rural areas, different countries.
 Some areas are associated with certain
kinds of diseases.
 The availability of readily accessible and
modern medical facilities can reduce
the delay in receiving effective medical
treatment. This leads to lower claims
rate.
 The cost of medical treatment and
health care are different in different
areas. Two insurers may have different
claims amount in average.
- Original policy of income protection insurance offered by two
insurers may be different. Eg different excess point, claim caps,
sickness excluded etc
- The mix of business may be different.
o If one insurer has larger market share, its claims
experience may be less volatile than the insurer with
smaller share.
- Underwriting of policy and claims may be different. Eg one
insuere’s underwriting process is stricter than the other one,
results in lower claims rate.
- One insurer may purchase facultative insurance, the other one
may not.
X 3.3

- Benefit
o It is a payment made by the state or an insurance
scheme to someone entitled to receive it.
o Benefits can be categorised into
 benefits on events that are unpredictable –
both whether and when they might occur
 benefits on events certain to occur, but
unpredictable in time
 benefits for immediate consumption
 benefits on events predictable in time
 benefits from the accumulation of disposable
income and capital.
o In this context, benefits are provided at the point that
the policyholder needs long-term care, eg annuities to
cover medical expenses, lump sum in cash

- Claim
o An assertion by a policyholder that an insurer is liable to
make a payment in accordance with the terms of a
policy
o In this context, claim is the payment requested by
policyholders for an insurer to cover expenses related
to their long-term care

- Product design considerations

o Marketability: attractive
 The insurer may offer a competitive (low)
price to enter the market
 Consider features that distinguish the
contract from that of competitors
o Profitability:
 Best use of capital available by developing
a profitable and cost-effective product
 The premiums charged should be
sufficient to cover the benefits to be
provided and the expenses and have a
margin for profit in most foreseeable
circumstances.
o Level and form of benefits
 Options, full indemnity, cash lump sum
  Integrate with State benefits?
o Early leaver benefits:
 Consider surrender value but may lead to
selective withdraw
 Principle when setting discontinuance
terms: Fairness between
 The policyholder or member who
is leaving
 The remaining policyholders or
members
 The provider of the benefits
o Interests and needs of customers
 Meet needs in a cost-effective manner
 Different features needed for different
customers
 Good value for money
o Risk appetite of the parties involved
 Meet the risk profile of intended customers
and insurer
 Insurer bears experience risk
 Consider inflation proofed investments
o Competition : whether other long-term care
providers are established in this market
o Terms and conditions of contracts:
 be kept simple, given the potential range
of customers
 be clearly defined to help control claim
costs and reduce the risk of damage to the
insurer’s reputation if claims are rejected
 Clearly define the trigger of claims e.g/ the
policyholder unable to carry out a certain
number of activities of daily living)
o Financing (capital requirements) : consider capital
available to support
 New contract, increased risk, higher
capital
o Regulatory requirements: adhere to regulation
o Administration systems:
 simple to administer
 Whether existing systems can carry out
the functions that have been built into the
product design
 The new product may need to
develop a new administration
system
X 3.4

(i)

- Past data can be used when determining the probability of

individuals leaving employment, becoming ill, retiring, being
married or other significant life events.
- Past data may not relevant to the future due to
o abnormal fluctuations
o changes in the experience with time
o random fluctuation
o changes in the way in which the data was recorded
o potential errors in the data
o changes in the mix of homogeneous groups within the
past data
o changes in the mix of homogeneous groups to which
the assumptions apply

- Demographic assumptions may be affected by changes in social

and economic conditions
o Mortality rates may have improved within three years
due to medical advances.
o Rates of ill-health retirement may have improved if the
company start providing gym benefits in recent years.
o Rates of withdrawal may be lower if benefits offered are
more attractive to employees in recent years.
o Rates of early retirement are likely to increase if the
early retirement benefits are improved.
o Salary scale may be different if the company is growing
well thus employee’s salary may have increased more
than few years ago
o Proportion married may be different due to social trend.
It may be a trend to marry at later ages.
- The relevance of past data to future projections must also be
balanced against the need for sufficient data for its analysis to
be statistically credible. In making a judgement about future
experience, this conflict between credibility and relevance must
be managed.
(ii)

Using past experience and considering how to deal with

- abnormal fluctuations
o Tow years ago there was a redundancy exercise in one
part of the business. The withdrawal rates is likely high
due to the departure of employees. These data should
be excluded when determining withdraw rates
assumption.
- changes in the experience with time
o Consider the improvement in mortality rates and adjust
the assumption.
- potential errors in the data
o Perform checks on the data before setting assumptions
- changes in the mix of homogeneous groups within the past data
o If in the past the data is not subdivided by type of
worker (e.g. manual, professional), then past levels of
salary growth will be distorted by changes in the
composition of the workforce.
- changes in the mix of homogeneous groups to which the
assumptions apply
o The company has recruited employees in a different
area of the business. Considering if we can assume the
same demographic assumptions for the new hired
employees. Eg. Mortality rates may be different for
people living in urban or rural areas.
X 3.5

(i) (a)
- Expenses can be split between fixed and variable, and direct
and indirect.
o Fixed expenses remain relatively constant in the short
term. Variable expenses vary by the amount of
business.
o Direct expenses can be identified as belonging to a
particular class. Indirect expenses cannot.
- Expenses need to be allocated by:
o Class of business
 Direct expenses are often allocated to class of
business using staff timesheets.
 Indirect expenses can be allocated using floor
spaces occupied by staff or computing costs can
be allocated using a “charge out” basis
o Function
 Initial expenses i.e. prelaunch development and
deign costs, sales overheads, replace of
mainframe computer, new head offices
 Maintenance expenses
 Renewal expenses
 Investment expenses
 Termination expenses, i.e. claims underwriting
and administration

(b)

The expense loading can be expressed as a

- fixed amount per contract eg administration expenses

- fixed amount per claim or percentage of claim amount eg
termination or claim expenses
- percentage of premium (eg commission) or sum assured (eg
underwriting)
- percentage of funds under management (eg investment
expenses)

Adjustments to pricing expense loadings

- Cross-subsidies
- Inflation
- Competition
(ii)

(a) The cost of the replacement mainframe computer

- Fixed, indirect cost
- The cost will be amortized over the expected future useful
lifetime of the computer
- The allocation to class of business and function should be done
using “charge out basis”.
- The cost will be allocated across all products and across all
functions (initial, maintenance and termination)
- The expense loading will be a fixed amount per contract.

(b) The building costs of the new head office

- Fixed, indirect cost
- Determine the total cost of build up the building and internal
decoration.
- This cost can be split by floor space occupied, between
department, then allocated to products in proportion to the
allocation of salaries of that department.
- This expense is likely to be allocated as an initial expense and
loaded as a percentage of premium/commission.
- However, the sales office may also carry out some renewal
work, in which case this should be allocated to
maintenance/renewal expenses using a fixed amount per policy
loading.
X 3.6

- No CI product currently offered in Country B, there is no claims

experience of target market.
- Other sources of data
o Experience on the CI contract offered in Country A
 This product has been sold for a number of
years, there is enough quantity of data
 Contracts offered in Country A and B will the
same or similar
 However, this data should be adjusted to reflect
assumptions made for Country B eg morbidity
rates
o Industry data
 The data may not be sufficiently detailed
 Need to check for differences in Country B and
the population collected for Industry data
o National statistics of Country B
 This is a developing country, may not have
enough statistics
 Large population, the data may be hard to
collect and not detailed enough
 This data can be already split by location (urban,
rural) and socio-economic groups
o Data from overseas contracts
 Claims experience of similar contracts offered in
other countries
o Tables, eg actuarial morbidity table
 May not include the critical diseases covered
under CI insurance policy
 Adjustments should be made to reflect Country
B’s morbidity rates
X 3.7

- Climate and Geographical location

Country A is a developed country. Historically Country B’s

population has been predominantly rural

o Levels and patterns of rainfall and temperature lead to

an environment that is associated with certain kinds of
diseases
o Natural disasters are more common in rural areas
o The availability or readily accessible and modern
medical facilities, with good transport and
communication networks, can reduce the delay in
receiving effective medical treatment.
These lead to a higher CI claim incidence rates for Country B
than A.

- Country B’s population have lower education level than Country

A.
o Literacy rates have improved by still low compare to
developed Country A
o Education influences the awareness of the components
of a healthy lifestyle, which reduces morbidity
o Poorer education is associated with
 Decreased income
 Poorer diet
 Poorer personal health care
These lead to a higher CI claim incidence rates for Country B
than A.

- Country B’s population may have poorer nutrition than Country

A
o Poor nutrition may be the result of economic factors
such as low income, or results of a lack of health and
personal education resulting in poor nutritional choices
o Poor nutrition increases the risk of contracting diseases
and hinders recovery from sickness
o Excessive eating and poor diet can lead to obesity,
which increase the risk of diabetes, high blood pressure,
heart problems and cancer. These diseases are probably
covered under CI insurance policy.
These lead to a higher CI claim incidence rates for Country B
than A.
 - Country B’s population may have higher CI incidence rates than
Country A due to poor quality housing.

- Income which influences nutrition and housing

o Country B’s rapid industrialization led to higher incomes
for individuals living in urban areas. They send their
income back to support their families in rural areas. This
helps improving the morbidity rates in Country B.
o However, Country A’s population is likely to have higher
average income than Country B, which allow them to
adopt
 healthier lifestyle, diet,
 better housing quality
 easier access to healthcare

These lead to a higher CI claim incidence rates for Country B than A.

- Temporary initial selection

o The mortality rates of lives who have recently been
underwritten and taken out policies are lower than
those of the same age who took out policies several
years ago.
o CI is a new product in Country B. It has been sold in
Country A for many years.
o CI claim rates may be lower in Country B and Country A.

- Time selection
o Morbidity rates may have improved in recent years due
to medical advances.
o Country B’s CI claim rates may be lower than Country A
since morbidity rates are lower than few years ago.

Overall, Country B’s CI claims rates is probably higher than that of

Country A.
X 3.8

- Objective or purpose: project the profitability of

launching CI insurance policy in country B
- Form
o Deterministic or stochastic
 Stochastic -allow naturally the
uncertainty of outcomes, the likely
distribution of outcomes
o Balance realism (with the risk of increased
complicity) and simplicity (so easier to build,
understand and check)
- Data
- Parameters and assumptions
o What assumptions and values to use, eg
morbidity rates of critical illness covered, CI
claims rate, CI claims amount, discount rate,
inflation
o how to allow for the projection of past trends, eg
taking into account the improve of morbidity
rates, inflation of health care
o If stochastic model is used, decisions have to be
made about the probability distributions for
stochastic variables
- Model source
o Buy a commercial modelling product
o Modify and use an existing model
o Develop a new model from scratch
o JKL will probably modify and use the existing
model for Country A’s CI insurance product
- Cashflows
o The model needs to allow for all cashflows that
may arise in the future
 Asset: single or regular premiums of CI
insurance product, investment returns
 Liability: annuity or lumpsum for CI
claims, expenses, tax, commission
o Decide what cashflows to model
o Interactions between different cashflows need
to be considered, and decisions made about
 whether and how to allow for them
- Projections
o Projection period and frequency
o Balancing the time taken to run the model (a
longer projection period and higher cashflow
frequency mean longer run times) with the
required accuracy of the results (calculating the
cashflows more frequently and should be more
accurate)
o CI may need long term care, projection period is
probably long
- Validation
o Sensitivity testing should be used to analyse the
variability of the results of the model to the
assumptions chosen
- Output
o Designed in an appropriate format to
understand easily
X 3.9
- The premiums determined as part of the pricing process
is the modelled cost, is the sum of risk premium and
expenses plus a loading for profit.
- The actual premium charged is the amount can be
charged under a particular set of market conditions and
may be more or less than the modelled cost.
- Factors influence the actual premium charged include:
o The distribution channels used
 JKL sells products in Country A via a
network of brokers. It needs to develop
channels for selling in Country B.
 This introduces extra cost.
o The level of competition in the market
 There is no such product currently
offered in Country B’s insurance market.
 Country B may be able to charge a
higher premium since there is no
competition
 Country B may also set a lower premium
to attract consumers and take a big
market share.
o The approach taken to expense and profit
loading e.g. marginal costing
o Country B may be a captive market that is not
price sensitive, since it is the only CI insurance
policy available
o Country B’s population may not be able to afford
the price JKL is offering in Country A, due to
lower income level. JKL may offer the product at
cheaper price