Subject 302, sept 2001, q8/revision book 7, q6

[claire3000006]

Hi

This question is:

A proprietary life insurance company markets unit-linked single premium whole of life investment contracts, which it distributes through intermediaries who receive initial commission on the sale of each contract but no renewal commission.

The contracts all have 100% allocation to units with no bid/offer spread and an annual management charge of 1% per annum of the unit value.

The sales director has suggested that in order to increase sales, the company
should increase the rate of initial commission it pays to certain intermediaries
that have satisfied the following criteria:

• The persistency of their business is better than average.
• The profitability of their business is higher because of a significantly higher
than average case size.

(ii) Describe the persistency and expense investigations that would be
performed in order to determine the amount of additional commission that
could be paid.

I took this question to be a profit testing type question, i.e. set profit criteria, set assumptions, project cashflows for intermediaries that are going to get special rate and determine what rates meet profit criteria and can therefore be offered to the intermediaries that meet the requirements.

However the answer seemed to be explaining how to determine whether the persistency was better than average, and then just an average expenses investigation, with no reference to how the commission rates will be determined.

Can anyone point out how I've misread the question?

Thanks

 

[Mark Willder]

Hi

This question is:

A proprietary life insurance company markets unit-linked single premium whole of life investment contracts, which it distributes through intermediaries who receive initial commission on the sale of each contract but no renewal commission.

The contracts all have 100% allocation to units with no bid/offer spread and an annual management charge of 1% per annum of the unit value.

The sales director has suggested that in order to increase sales, the company
should increase the rate of initial commission it pays to certain intermediaries
that have satisfied the following criteria:

• The persistency of their business is better than average.
• The profitability of their business is higher because of a significantly higher
than average case size.

(ii) Describe the persistency and expense investigations that would be
performed in order to determine the amount of additional commission that
could be paid.

I took this question to be a profit testing type question, i.e. set profit criteria, set assumptions, project cashflows for intermediaries that are going to get special rate and determine what rates meet profit criteria and can therefore be offered to the intermediaries that meet the requirements.

However the answer seemed to be explaining how to determine whether the persistency was better than average, and then just an average expenses investigation, with no reference to how the commission rates will be determined.

Can anyone point out how I've misread the question?

You are correct to say that the commission levels will be set following a profit testing calculation. However, before we do the profit test we will need assumptions for persistency and expenses (and lots of other assumptions too).

The question has only asked you to consider the persistency and expense assumptions. The profit test itself is beyond the scope of the question (perhaps another department will then take your figures and do the profit testing you have described).

Best wishes

Mark