Paper 1 – April 2018 - Q5 (iii)

[Ester]

I'm a little confused about this part of the question.
1) I don't understand how the insurance will work on practice and how it will be affected by the different financing methods.
2) I though the employer would pay a single premium to the insurance for taking up the risks, no? Or the premium paid to the insurance will depend on the financing method?
3) How the pay as you go method would work out?
4) What about new members? Will their risk also be transferred to the insurance?
5) Under regular payment it stated "There may be a problem for the insurance company with the regulation on choosing this approach." Why?

Thanks

 

[Helen Evans]

Hi Ester

This is a challenging question. I agree in practice it would be usual for a single premium to be paid to secure the benefits (normally the transfer to an insurer is for a scheme which is closed to future accrual and the scheme wants to pass the liabilities to the insurer for a single premium).

In this case though the examiners are asking us to explore if that weren't the case, ie we look at possibility of different funding methods (ie different timings of paying the premium) and how feasible that would be.

In relation to PAYG the solution in the main part is saying it doesn't really work, ie the insurer would require money upfront not as each benefit payment falls due and then looks at some alternatives (eg using PAYG for changes in membership / admin expenses ... although the comment about lump sum on retirement I would say is terminal funding!). There is only one comment in the insurer section about using PAYG in its purest form, ie finding money at last possible moment and that's the point about no investment fund.

In terms of your comment on new members, yes I read the qn as they will be covered by the insurance too (hence the comment in the marking schedule about when new members join).

In relation to regulation and regular premium, I think it is getting at the idea we need to set up prudent reserves upfront but will have received little premium (note the same concern to an even greater degree would arise if we did adopt the PAYG approach with no money until benefits fall due).

Sorry its a complex qn!

 

[JL24]

Hello there, I have some questions relating to this, particularly for the answers to the 'Regular Payments' funding method. Would appreciate it if someone could provide their input!
1. Why could it potentially be a more expensive approach to employer? Is the employer paying for the initial expenses incurred by the insurer in setting up the scheme, and then also paying regular premiums?
2. 'The insurance company is unlikely to allow for the expected differences in experience (compared to the pricing basis) and hence is more expensive. If the experience for the scheme is favourable then regular premiums could be adjusted to reflect this.'
- Does this mean that because the potential difference in experience is not allowed for, the insurer charges higher regular premiums by including a margin? Thereafter, if experience is favourable, this regular premium is then reduced?
- Why is there no allowance for the expected differences in experience?
3. 'Conversely if the experience is unfavourable then it is unlikely that the insurance contract cost will be changed and therefore this approach could be cheaper than using regular premium to fund.'
- Does this mean that the regular premium is not increased even if experience is unfavourable, and why? What is 'cheaper than using regular premium to fund' referring to?
4. 'The insurer would want to make profits and this will be allowed for in the cost, but not in the regular payments made.'
- Does 'cost' refer to the upfront costs incurred? Why can't it be included in the regular premiums?

Thank you in advance!