Chapter 1 - Escalating benefits and premiums

[Alan2007]

Chapter 1 Page 21

I dont understand the 2 core-reading paragraphs

The core reading paragraph is:

Designs in which benefits escalate when not claiming usually feature escalating premiums as well. A simple and popular design has the premiums increasing at the same rate as the benefits. This effectively means that the increase is based on the premium assumption prevaling when the original contract was effected

Can you please explain the underlined?

Some protection against trends in claims experience (and high inflation) may be obtained by an alternative design whereby the increase in premium is based on the current.......................................
There are a number of possible variations on these two designs.

I dont understand any of the above paragraph?
How can high inflation be bad for the insurer if both the premiums and benefits increase say at 3%?

Thanks

 

[amaster]

I'll hazard a guess...

since the premiums increase at some rate (being the same rate for benefit increases), this rate is likely to be taken into account when setting premium assumption.

therefore is taken into account when the contract comes into effect.

 

[amaster]

for the second paragraph, to protect against adverse experience, the insurer will want to increase its premiums or reduce its benefits (liability).

this will happen if the rate for premium increases exceeds that for benefit increase.

by increasing premium and benefit at same rate from some time point t, then the policyholder has benefited since premiums already paid are less than would've been if the new benefit amount was taken at outset.

therefore you will need a greater rate on premiums than for benefits...

I hope someone could confirm my initial thoughts...

 

[Cymro Card]

At a guess (and not having the notes to hand) expected benefits increase with age. If premiums are only to increase in line with benefit increases, there must be some *cross-subsidy* of earlier premiums paying for later premiums benefits. With high(er than expected) inflation the benefits as the p/h ages increases more dramatically, and although the premiums will have also increased, the cross-subsidy bit won't be enough, meaning that the insurer is in trouble! Hope that's clear/right!!

 

[Zebedee]

Hi

I didn't study ST1 but I do work in life and CI pricing and can see what the course notes are trying to say here.

The first situation described is that where increases (e.g. indexation) use the premium rate tables that applied at policy commmencement. The insurer may have repriced since then, increasing or decreasing their premium rates as apppropriate. However, they are locked in to the old premium rate basis and forced to use rates that they now consider inappropriate. The latter case is where increases are based on the premium rates applicable at the time of the increase. Fewer guarantees for the policyholder but better for the insurer. High inflation accentuates the problem with the former case because a higher proportion of the total policy end up being based on "wrong" premium rates.

Hope that helps...