Question:
A life insurance company that primarily sells term assurance business is looking to introduce a new version of the product. This version would be offered online and via insurance intermediaries. Two potential product designs are under consideration, Option A and Option B.
Option A:
A term assurance with a simplified underwriting process whereby customers are accepted provided they can answer a series of basic questions. The minimum term of a policy is 5 years.
Option B:
A term assurance using the company’s standard underwriting process, but offering the option to convert the policy into a whole of life assurance at the end of the term with no further underwriting at that stage. The premium will be revised at the point of conversion to reflect the policyholder’s age and the original underwriting decision.
Discuss the factors the company would consider in comparing the two designs.
Background
I find the question is having a complicated design, which need to compare pricing factor between 2 product, while making reference to 2 different distribution channel. This may be a good news since it allow room for a lot different perspective and comments.
I have sat this exam in this sitting (2 marks away from passing), and in fact spent a lot of time in constructing the answer, which left me insufficient time in finishing my answer. In fact, i have spent 45 minutes for this question, as compared to expected time of 29 min, yet scoring only 8 marks out of total 16 marks.
Comment from examiner's report:
This question required the candidate to identify a number of factors, and then to discuss the relative merits of the two options regarding these factors. Most candidates were able to identify most product design factors from the core reading, and then sensibly used these to structure their discussions. Better prepared candidates had a good range of factors and produced a more detailed discussion on each factor with comparisons between the two products.
Query
1) Appreciate if any tutor or senior in the forum can have a look on my answer attached below and share if there is any opinion or specific perspective for me to improve my exam skill.
2) I have purchased Asset in previous sitting (hence covering FY2019-FY2021), and i find the "Overview" and "comments about exam technique" in the boxes is really helpful. I am wondering if anyone is kind enough to share the "Overview" and "comments about exam technique" for this particular question which i have lost so many marks for me to improve my exam technique further.
Sorry for the long question and inappropriate query, however i am really looking forward to further help on the exam technique as i always been scoring marks that are 2-3 marks away from passing mark in actual exam and mock exam.
Answer submitted in exam
Channel – complexity, target segment, affordability, expense
- Online distribution channel is having structure which may reduce expense since there is no commission expense needed,
- as compared to insurance intermediaries where the commission level may be competitive hence will incur higher cost
- Online distribution channel is targeting a wider range of customer, however probably may attract customer with less financial sophistication, lower income level and lower wealth level
- While insurance intermediaries is charging regular fee to their customer, hence most probably customer segment is from greater financial sophistication, higher income level and higher wealth level
- Hence, the product to be distributed via online distribution need to be relatively simple without complicated design like additional guarantee or option, and preferable to have no or simplified underwriting process
- As compared to insurance intermediaries who is looking for the best product to suit their customer, regardless of the higher complexity or prudent underwriting process
Profit – expense, risk margin, volume, commission level
- The profit is a function of different variables which include new business volume, expense, risk margin required, commission outgo, sufficiency of premium rates and suitability of channel which decide marketability and new business volume
- Hence it is hard to compare profit between both option in view of the product are to be distributed via both online and insurance intermediaries
Marketability and new business volume
Option A
- Option A is having simplified underwriting with some basic questions only, hence having lower underwriting prudency which may attract greater new business volume in view of the convenience and efficiency in getting insurance protection
- However, there is greater uncertainty of future mortality experience due to lack of underwriting prudency, hence greater risk margin is needed in pricing basis to prudency, which may lead to higher and less competitive premium rates
- This may lead to lower than expected new business premium in online distribution, if there is other more competitive product from competitor in online platform
- The higher and less competitive premium rates may not be suitable to be distributed via insurance intermediaries, as they are consistently looking for the best product for their clients, which may be discouraged by the uncompetitive premium rates. Hence option A is having lower marketability via insurance intermediaries
- Hence, option A may be more suitable with higher marketability to be distributed via online with simpler design, feature and underwriting approach
Option B
- Option B is having additional mortality option which allow conversion of term assurance to whole life without underwriting, which would improve the marketability
- While full underwriting is in place in option B, risk margin for prudency may be reduced, hence the premium rates would be relatively competitive, which would be beneficial to be distributed via insurance intermediaries with higher new business volume, hence may increase the aggregate profit despite higher commission outgo and additional cost due to mortality option
- While option B is having a more complicated design due to mortality option and complicated underwriting process, it may reduce the marketability if it is distributed via online, hence may not be suitable for online
Rick characteristics
- Both options are term assurance with death benefit payable, hence both are sensitive to higher than expected mortality experience.
- Option A is having simplified underwriting process, hence may be having greater anti-selection risk as customer may tend to withhold their health condition, or give false health info, especially in online distribution0
- However normally the benefit level will be capped at a relatively low death benefit
- Option B is having full underwriting, hence there is less uncertainty regarding the future mortality experience with lower anti-selection risk and greater knowledge on life insured’s health condition
- Hence option A may be less sensitivity to increase in mortality rate as compared to option B
- Normally, term assurance is having comparatively low premium rates as compared to other product type, hence both product will be sensitive to higher than expected expense, which lead to insufficient expense loaded in premium rates to cover higher than expected expense in future.
Sensitivity to profit
mortality risk
- Assuming option A is having lower max death benefit as compared to option B with higher benefit level with full underwriting
- While Option B is having additional mortality option which allow conversion of term assurance into whole life without further health evidence, which increase the probability of claim from less than 1 to 1, however with uncertain timing of claim
- Option B is more sensitive to mortality risk in future, if mortality rate is higher than expected, the negative impact on profit in option B would be more significant as compared to option A
- However, this may be partially offset in option B due to the reviewable premium rates upon conversion
expense risk
- Option A is having lower initial cost due to simplified underwriting as compared to option B with higher cost due to full underwriting process, hence the expense level in option A may be lower than option B
- While option B is having conversion option to whole life, which increase the expected policy duration significantly, as whole life policy only terminated when life insured die
- This would increase the overall regular administer expense and increase expected claim expense in option B as claim is now definitely to be paid in future
- negative impact from inflation is higher in option B, probably due to higher expense level and higher expected policy duration
- hence option B is more sensitive to expense risk as compared to A
Financing requirement
- Option B require more reserve due to higher liability from higher expected cost of the mortality option
- Hence option B would require greater financing requirement due to higher liability, reserve and greater solvency capital requirement, as compared to option A
Administration system
- Option A is having relatively simple design with simplified underwriting, hence probably no additional requirement on system as the product has been selling term assurance primarily
- Option B with full underwriting process with additional mortality option for plan conversion, which may lead to additional admin resource constrain
- Or may lead to high requirement on admin system, probably need to enhance current system or build a new system, which would need greater development cost, and hence may have higher new business strain as compared to option A
- There may be higher operational risk in option B due to frequency of error, for example wrongly process In system for policyholder who did not decide to convert by exercising the mortality option, however system may have error and identify him wrongly as customer who want to convert, and charge premium continuously to the customer
- This may lead to reputational damage or regulatory intervention,
- Which may reduce new business volume or additional financial loss from fine or compensation to customer
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