Product Design

[Sayantani]

Chapter 16, Practise Question 16.3
In the solution ii) Factors in Redesigning and Repricing
It is mentioned to profit test the premium used by competitor on company's own experience basis and RDR.
Then if its profitable then the actuary can re define the expenses, mortality and interest elements of the premium basis.

My confusion is if the premium charged by competitor makes the product profitable on company's own pricing basis then what's the need to change the pricing basis after that to duplicate the competitor's premiums.
Also why would the competitors' lower premium make the product profitable on company's own pricing basis . Does this mean the company was charging higher premiums before in spite of being profitable maybe to include higher profit margins ?
Maybe I am confused with the wordings of the material.

 

[Sayantani]

I do have another doubt related to Chapter 16.

• In Section 1.9 Under Extent of Cross Subsidies, in the last paragraph it is mentioned that there will be very little contribution from the smaller policies to overheads as compared to the larger policies which is what cross-subsidy is. The solution to this is mentioned by using fixed per policy fee which can be made equal to the per policy admin costs. But won' t this again give rise to the same problem that the fee might be too much for a small policy and appear uncompetitive. Also how is it helping to cover the overhead costs because the contribution is particularly for admin costs?
• In Section 1.3 , in the paragraph just before the question it is mentioned that " For term assurance...the amount of expenses loaded for as a fixed charge will be important. For single premium endowments the interest rate is critical as is the amount of expenses loaded for as a proportion of premiums". Why is it that for TAs, expenses are mostly taken as a fixed charge? Is it because generally for TAs, the premium size is small so it doesn't help to take much of the marginal costs as percentage of premiums ( of course apart from commission and other expenses which are dependent on premiums). While for single premium endowments the expense loadings as percentage of premiums are given more importance as compared to the per policy fixed ones?

 

[Lynn Birchall]

Hi

Taking the points about Practice Question 16.3 first ...

My confusion is if the premium charged by competitor makes the product profitable on company's own pricing basis then what's the need to change the pricing basis after that to duplicate the competitor's premiums.

Various possible reasons I think - for example, the profit testing may have been done just for sample policies or may have involved more grouping of policies into model points, and company needs it premium rates to be more granular. Also, this result from the profit test, and the investigations that went into setting the assumptions for it, may indicate that the company's pricing basis is now out-dated and should be updated to reflect this new view.

Also why would the competitors' lower premium make the product profitable on company's own pricing basis . Does this mean the company was charging higher premiums before in spite of being profitable maybe to include higher profit margins ?

It does mean it was charging higher premiums. This could have been a deliberate decision at the point the pricing was undertaken to include higher profit margins. However, as mentioned above, it may simply reflect that the pricing took place a while ago and the experience has been better than the company originally expected (so maybe time to update the premiums)

 

[Lynn Birchall]

I don't think you have too much to worry about with your understanding of either Section 1.9 or 1.3.

In Section 1.9, the use of a policy fee equal to the per policy admin costs is a 'solution' to making small policies cover their own marginal costs. You're absolutely right that this may then result in uncompetitive terms.

In Section 1.3, the main point being made is about the relative impact of interest, mortality and expenses on competitiveness - with mortality (especially) and expenses being important for term and interest (especially) and expenses for the SP endowment. As for the form of that expenses for a SP endowment, maybe it helps to think of an example: someone paying a SP of 100,000 (say) is going to be more impacted by the percentage part of something such as '100 per policy + 1.5% of the SP).

Hope these help reassure!