Chapter 3 - Product bases

[rlsrachaellouisesmith]

Hi

In this chapter under the Unit linked section there is no mention of persistency risk as a key risk to insurers - given early withdrawals do present a risk, why is this not mentioned as a key risk for UL products?

Is there any information on how investment linked basis charges compare to unit linked basis charges - would it be correct to say that IL contract charges have the potential to be less transparent due to the complex nature of the product when it involves capital guarantees as well as investment upside?

It also mentions a risk particular to IL policies. May not be able to match the guarantee liability precisely. Due to:
- time lag --> does this relate to time lag between changes to index and corresponding changes to the assets invested in (if fully replicating the index), or is this something else?
- unable to create a portfolio that replicates the index e.g. no derivative available, and instead have to partially replicate or fully replicate (but with time lag effects).

Thank you

 

[Lindsay Smitherman]

In this chapter under the Unit linked section there is no mention of persistency risk as a key risk to insurers - given early withdrawals do present a risk, why is this not mentioned as a key risk for UL products?

Yes there will of course also be persistency risk - the section is not intended to be comprehensive, just to highlight a few risk areas of note.

Bear in mind that it isn't only early withdrawals that present a downside risk to the insurer. Any withdrawals could well be adverse, given that they mean that the insurer will then no longer receive the stream of charges from the p/h (from which it takes its profit), and it is unlikely that a surrender penalty would recover all such charges, particularly for longer-term business.

 

[Lindsay Smitherman]

Is there any information on how investment linked basis charges compare to unit linked basis charges - would it be correct to say that IL contract charges have the potential to be less transparent due to the complex nature of the product when it involves capital guarantees as well as investment upside?

By 'investment-linked' do you mean index-linked products where the link is to an investment index, such as a guaranteed equity bond? (Bear in mind that unit-linked policies are themselves 'investment-linked'.)

The relative levels of charges will depend on various comparisons between the two, such as the level of any additional death benefits that each might offer. A contract with a guaranteed index link would need to cover the costs of providing that guarantee (eg purchasing the related derivative). Any comparison with a UL contract would need to consider whether there were any guarantees offered under that.

Although there may well be explicit charges such as allocation rates applied to guaranteed investment bonds, you are right in that some of the charging is effectively implicit within the degree of generosity of the guarantee provided (eg the % of index shared in) - and perhaps due to the p/hs not appreciating that an equity index only provides capital growth and not full equity return.

 

[Lindsay Smitherman]

It also mentions a risk particular to IL policies. May not be able to match the guarantee liability precisely. Due to:
- time lag --> does this relate to time lag between changes to index and corresponding changes to the assets invested in (if fully replicating the index), or is this something else?
- unable to create a portfolio that replicates the index e.g. no derivative available, and instead have to partially replicate or fully replicate (but with time lag effects).

Apologies but I can't find the explicit reference to 'time lag' in the Core Reading so I'm not 100% sure which bit you are referring to. My initial reaction was that it might be referring to the indexation lag if (say) using index-linked bonds to match inflation-linked liabilities, as is covered in Subject CP1. However, if you mean the more loosely worded 'due to timing of investments', then this is covered in Practice Question 3.5 in this chapter.