CONVENTIONAL

NONPARTICIPATING
CONTRACTS

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.
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 type of basis used for a product has important implications for
The cost of the product, 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, 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 ;
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,
after the first premium has been paid and all the initial expenses

OPERATIONS OF FUND

Figure1. Illustrations on how a nonprofit fund operates.

The Risks Involved

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

The Risks Involved

Withdrawals - When the asset share is negative (most likely to
be negative in the first few months or years of a regular premium
contract, because of high initial expenses), there is a financial
risk from withdrawal. At other times, whether there is such a risk
depends on how any withdrawal benefit paid compares with the
asset share.
Mortality there will be a significant mortality risk at the start
of the contract, but this will reduce as duration in force
increases. (Including anti-selection risk) A mortality risk may also
arise from selective withdrawals. 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.

Capital Requirement
The capital requirements of the business depend crucially on:
Contract Design
o The key issue in contract design, is whether the design enables
reserves and solvency margin requirements to be kept low.
o The lower the initial reserves, the lower the initial capital
requirement. The slower the increase in reserves over the contracts
term, the faster any invested capital is released. This issue therefore
interacts with the issue of how supervisory reserves are calculated.
Premium Payment Frequency
o For non-participating contract, the following is the order of the
capital required:
Regular monthly premium (most capital needed). Regular annual
premium.
Single premium (least capital 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, on the reserving basis, to
meet the expenses and the benefit. Capital will therefore be needed
to set up the required reserves at outset. The stronger the reserving
basis compared with the pricing basis, the more capital is needed.
Since supervisory reserves have to be prudent, they are often
stronger than the pricing basis, and this is a significant contributor
to the total capital requirement.
Level of Initial Expenses.
o The higher the level of initial expenses the less the initial asset
share will be. If nothing else changes, then clearly this will increase

Setting Assumptions for Pricing

Demographic Assumptions (relates to mortality rates)
The actuary will consider the companys recent experience of the
contract, or related contracts. This will allow appropriate adjustment
to be made to standard tables. Industry data and reinsurers data may
be useful, especially if the company has little relevant data. 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

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

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, 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. It must be
consistent with the investment return assumption.

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, allowing for future premium
income and for the anticipated returns from investment, the liabilities of
the life office will be met as they fall due.
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.
The expenses that the life office will incur in the future in order to
administer the contracts of insurance it holds.
The obligation to provide a return to those with a stake in the company
for the capital that they have provided; that is to the with-profits
policyholders and/or shareholders, as appropriate

Case Study 1

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

Case Study
The premium excluding profit margin = RM377.3
Total premium = RM405.6

Fill in the blank and produce the solutions by using excel.