Guaranteed Equity Bonds

...in chapter one...does anyone know why they are only single premium and not regular premium products?

 

Hi

I wonder about that idea too..i thought it might be to do with the fact that the guarantee in teh product implies a large liability that creates a large new buisness strain that must be partially offset with a large single premium as opposed to smaller regualr premiums spread over several years...

 

though please could somebody confirm wether this is the reason or what the exact answer is

 

Single premium

The main reasons I think you don't see regular-premium versions are complexity and cost.

With regular premiums, you would have to accumulate each (monthly) premium from its payment date to maturity in line with the index. This would get quite complex for, say, a 5 year monthly-premium contract. It would also be hard to make it clear to policyholders that this calculation has been performed correctly.

If every policy is backed by either:

1. Calls (to give equity upside) and FI bonds (to meet the guarantee); or
2. Shares (to give the equity up-side) and puts (to meet the guarantee)

then the insurer would have to purchase derivatives on a monthly basis which would be expensive. When you consider that different policyholders would choose to pay premiums on different days, the company would need to be very active in dealing in the derivatives(i.e. on a daily basis) to back the guarantee!

The resulting high charges would put off most policyholders (and insurers!).

Because of this, they tend to be single premium contracts. They also tend to be launched in tranches, so that all the GEBS in a single issue start on the same day and have same term. This makes it easier for the insurer to back by only buying the OTC derivatives on the launch date.

 

Why GEBs are single premium products

Paul's second point gets close to the main reason.

Since the key to these products is the correct derivative backing, the terms that a company can offer policyholders is crucially dependent on the price of the derivatives, which will be constantly changing.

With the single premium version, a company will agree provisional terms with an investment bank to buy up to a certain amount of the required derivative. The company can then price the product, and assuming the terms don't worsen prior to launch, can then sell up to the agreed amount to policyholders and buy the required amount of derivative backing from the bank.

(As an aside, I know of one company where the terms did worsen between initial agreement and launch. The prudent thing to do would have been to alter the product terms or delay the launch, but instead the company decided to launch the product anyway and put off buying the derivative backing in the hope that the terms would move back in the comapny's favour. Unfortunately, the terms got worse and worse and by the time the company did buy the derivatives, they had lost far more than they would ever make from the product!)

A company wanting to offer a regular premium version wouldn't know what terms it would be be able to get for future derivative purchases, so wouldn't know what terms to offer policyholders. The theoretically correct terms would be constantly changing anyway, making cross-subsidy over time a big issue. You might suggest buying all the derivatives now at known prices, but this would involve making estimates of new business volumes, withdrawals, mortality etc. These estimates would never be correct and so you'd end up with the wrong amount of derivatives and so either have wasted money or have insufficient protection. This would lead to excessive risk for the company and a product that would be too expensive to sell.

Of course, a company could choose to issue a regular premium version (investment houses do offer tracker funds with downside protection of various types), but the risks are far greater and such products aren't covered by SA2.

That's more than I expected to type, but I hope it's helpful.

 

Hi

Thanks very much Paul and Mike for that information .......

 

many thanks Paul and Mike for detailed explanation.