Series X assignment 5, Question X5.7 (Reinsurance)

[Trevor]

Hi, I am trying to understand a point on Question X5.7 part (iii) of the 2019 version of Series X assignment.

The question is what type of reinsurance is suitable for a unit-linked critical illness (CI) contract. The solution for this is that individual surplus reinsurance will be used.

How does this work? The payout for a unit-linked contract will be the unit fund value. In such case, whether the claims are within or above the retention limit depends on the fund value, which depends on the premium paid. From the reinsurer's perspective, a policy will switch from "not-covered" to "covered" simply because the fund grew beyond the retention limit.
If the retention limit is actually applied on the sum at risk instead of claim amount, then the policy needs to have a minimum benefit guarantee to have a sum at risk.


Also related to this question:
How do we have a combination of an individual surplus(IS) and original terms(OT) reinsurance?
My understanding of original term reinsurance is that, the premium is split between the cedant and reinsurer, in the same portion as the claims.
ie: premium split % depends on claim split %
So if we have IS and OT, our claim percentage will be retention level/Claim amount, and then the premium will split based on this percentage. This means each policy will have a different % split of premium depending on their sum assured. Is this correct?

I always assumed OT has to be paired with Quota Share (QS), so that the premium and claims will always be the same percentage (R%).
Does a QS reinsurance automatically imply the premium has to be split by the same R%, or it only specifies R% split for claims but premium splitting depends on whether it is OT or RP (Risk Premium)?

Best Regards,
Trevor

 

[Mark Willder]

Hi, I am trying to understand a point on Question X5.7 part (iii) of the 2019 version of Series X assignment.

The question is what type of reinsurance is suitable for a unit-linked critical illness (CI) contract. The solution for this is that individual surplus reinsurance will be used.

How does this work? The payout for a unit-linked contract will be the unit fund value. In such case, whether the claims are within or above the retention limit depends on the fund value, which depends on the premium paid. From the reinsurer's perspective, a policy will switch from "not-covered" to "covered" simply because the fund grew beyond the retention limit.
If the retention limit is actually applied on the sum at risk instead of claim amount, then the policy needs to have a minimum benefit guarantee to have a sum at risk.


Also related to this question:
How do we have a combination of an individual surplus(IS) and original terms(OT) reinsurance?
My understanding of original term reinsurance is that, the premium is split between the cedant and reinsurer, in the same portion as the claims.
ie: premium split % depends on claim split %
So if we have IS and OT, our claim percentage will be retention level/Claim amount, and then the premium will split based on this percentage. This means each policy will have a different % split of premium depending on their sum assured. Is this correct?

I always assumed OT has to be paired with Quota Share (QS), so that the premium and claims will always be the same percentage (R%).
Does a QS reinsurance automatically imply the premium has to be split by the same R%, or it only specifies R% split for claims but premium splitting depends on whether it is OT or RP (Risk Premium)?

Best Regards,
Trevor

Hi Trevor

I think you're getting confused with the benefit for this one. If it was a SP2 endowment then the benefit would be the unit fund. But IP pays out an income while the policyholder is unable to work.

Both IS and QS can be either RP or OT. If QS is OT then premiums and claims are split say 40% reinsurer, 60% insurer on all contracts. If IS is OT then premiums and claims may be 40% to the reinsurer for a small policy, but premiums and claims may be 60% to the reinsurer on a larger policy.

Best wishes

Mark

 

[Trevor]

Hi Mark,

Thanks for the clarification on reinsurance types.

For the unit linked IP, how does benefit system works?
Based on the ActEd text in chapter 3 page 22,
point 6 is saying the annuity amount (long term care or IP) will be paid out from the non-unit reserves/fund.
Does that mean despite being a saving contract, the benefit amount will not grow in line with investment returns?

And then point 5 mentions the unit fund is paid out death or surrender.
What if the IP/LTC has no maturity/death/surrender benefit? When will the unit fund value be returned to the policyholders?

 

[Mark Willder]

Hi Trevor

I'm very sorry, it was me that was getting confused. I'm not sure why I thought this was an IP question when it is CI.

CI works in exactly the same way as the death benefit in Subject SP2. So the best approach is to use risk premium on a sum at risk basis. The sum at risk is the sum assured less the unit fund value. So as you've said in your first post, the fund could grow so that reinsurance is no longer needed. This isn't a problem - the premium and the benefit are both based on the sum at risk, so they both go to zero when the fund exceeds the sum assured. But as I mentioned before, the risk premium could be IS or QS.

We can have unit-linked IP and LTCI too (although not in this question). There are two types depending on whether the unit fund is protected. If the unit fund is not protected, then the income benefit is paid out of the unit fund until it is exhausted, and then the rest is paid from the non-unit fund. If the unit fund is protected, then the income benefit is paid from the non-unit fund throughout.

These contracts are not necessarily savings contracts. It is possible to have unit-linked contracts that are almost entirely protection. Premiums are set to be just enough to keep the fund big enough to cover the morbidity charges for the next five years say and then the premiums are reviewed to ensure that the charges can be met until the next review.

The benefit guarantee (income level for IP/LTCI or sum assured for CI) typically is unconnected to the unit fund value.

It would be very unusual if the unit fund was not paid out on death/maturity/surrender.

Apologies for the earlier confusion.

Best wishes

Mark

 

[Trevor]

Thanks Mark,

Just to clarify on the funds being protected, or not, is the 3 bullet points at the top of chapter 3, page 23.
If theses periods are applicable on a policy, does this make up an unprotected unit fund?

A few more follow ups:
1. If there are remaining unit fund value after death, what happens to them? Do they get returned to the policy holder's dependant?

2. Would the policyholder be concerned the investment performance? Eitherway, they are getting the same benefit amount just where do they come from.
What if someone the policyholder is already in the claim state of long term care and the unit fund runs out (because they chose a very risky fund previously)?
Unless the insurer changes higher premium at the outset if they think the claim is likely to be paid from the non-unit reserve.

3. If the reinsurer reinsures a unit linked policy based on sum at risk, they are taking investment risks from the insurer. How do they control this? Ultimately it is the policyholder’s choice on the investment risk they are taking

 

[Mark Willder]

Hi Trevor

Yes, the material on page 3 you are referring to is looking at a unprotected unit fund.

1. Yes, remaining funds can be paid to dependants.

2. A risky fund choice increases the chance of the fund running out and so the policyholder having to increase their premiums to keep the cover going, so it matters to the policyholder. The insurer will only offer funds that it is comfortable with.

3. The reinsurer isn't really taking on investment risk in that sense. If the unit fund falls then the sum at risk increases and the reinsurance premium increases (as it is based on the sum at risk).

Best wishes

Mark