Hi there, Please could you explain the logic of the following: "Expense risk is a large risk for term assurances as expenses form a relatively large proportion of the premiums". Why is the fact that they're a large proportion a source of risk? Thanks, Matt
Hi Matt This sentence doesn't say that the fact that expenses are a large proportion of premiums makes them a source of risk. But it is saying that it makes this risk more important than it would be for other contracts. For example, expenses could be estimated to be 20 and there is a risk that in fact they turn out to be 25. This is a big risk for a term assurance with premium of 50, but not such a big risk for an endowment assurance with premium of 250. Best wishes Mark
Thanks for your reply Mark. Apologies if I’m overthinking this. So, just to be clear, are we saying that: Given expenses are a large proportion of the premium, then they’re a price driver on TAs, and so slightly overestimating them will increase the price but a large % making premiums uncompetitive. Or, are we saying that b/c TAs are low margin products, then if expenses are underestimated there’s not much profit margin to eat through before we’re making a loss? But surely the same argument could be made of mortality (ie small profit margin and so any inaccuracy could wipe out the profit margin).
Hi Matthew I think you're reading more into this sentence than was intended. We really are just saying that expense risk is a large risk for term assurances because they make up a large proportion of premiums. But looking at your statements above then I would say that these are all true as well. So yes, as expenses are a big proportion of premiums they are a key driver of premium (as well as being a key source of risk). So yes, the premium will be very sensitive to change in the expense assumption. And yes, term assurances operate in a very competitive market so can have low margins. So yes, if we underestimate expenses there won't be much profit margin to eat through before the contract becomes loss making. And yes, the same argument can be made for mortality as this drives claims. Best wishes Mark
