PRICING INSURANCE PRODUCTS

For Life Insurance, the pricing process results in setting a premium rate, which is the charge per unit of life insurance coverage. Pricing of any insurance product generally involves

           

• Selecting pricing objectives & a pricing strategy for the product
• Setting and profit-testing actuarial assumptions
• Managing the results of the product’s pricing.

Setting Pricing Objectives & Strategies

A pricing objective is a goal that specifies what a company wants to achieve with a product’s pricing. It is expressed in terms of profit, sales & market share.

A pricing strategy is a general guideline for using a product’s financial features as a variable in the marketing mix. Some strategies include Cost-driven pricing, Competition-driven pricing & Customer-Driven pricing.

A product’s pricing must balance the different requirements of an insurer’s various stakeholders. One delicate balance is between company profitability & company solvency.

Making Assumptions for Pricing

Actuaries use a mathematical product model that is part of a computer programming package. Actuaries enter into the product model a set of assumed values for the elements of a given product’s pricing. These elements include

·         Investment earnings

·         Cost of the benefits payable

·         Loading charge

Each assumed value used in life insurance and annuity pricing is known as an actuarial assumption.

Investment Earnings and Interest Rates

Net Investment income = investment income - investment expenses.

Investment Expenses = Management Fees + Transaction Fees + Administrative Expenses

The growth of an investment depends upon interest rate, growth period.

Interest rate	Increases	Value of invested sum will	Increase
	Decreases		Decrease
Growth Period	Lengthens		Increase
	Shortens		Decrease

Cost of Benefits and the Mortality Factor

A product’s cost of benefits is the value of contractually required benefits the insurer promises to pay to customers. It equals all of the insurer’s potential payments of benefit obligations to customers multiplied by the expect probability that each benefit will be payable. The cost of benefits does not include company operating expenses and the expenses of investing.

Cost of Benefits = Benefit Obligations * Probability that a Benefit will be payable

Types of benefits potentially provided by LI & Annuities include

• Death Benefits for Life Insurance
• Cash Surrender Values
• Partial Withdrawals
• Periodic Income payments
• Death benefits & survivor benefits

Cost of Benefit for Life Insurance also known as Cost of Insurance is

            Cost of Benefits = Death Benefit * Mortality Rate

The cost of benefits for an annuity is affected by the type of annuity

Involved – immediate or deferred and the payout option selected-for example a life annuity or an annuity certain.

During the payout period of a life annuity the benefit costs for each year depend upon

Cost of Benefits   =   Annual Income     *       Probability of annuitant’s

For the year              payment                       survival to the next year

Higher the mortality rate for a group of life insured’s, the higher the cost of life insurance benefits and higher the premium rate for the block of life insurance policies issued to that group. The higher the mortality rate for a group of life annuitants, the lower the insurer’s cost of providing periodic income payments.

Mortality Tables

Mortality Experience is the number or rate of deaths that actually occurred in a given group of people during a given year.

Annuity Mortality Table shows the projected mortality rates for a population consisting of annuitants only.

Life Insurance Mortality Table shows the projected mortality rates for a population consisting of life insured only.

Basic Mortality Table has no safety margin built into the mortality rates and that is used for pricing life insurance or annuity products.

Valuation mortality Table has a safety margin built into the mortality rates and that is used for calculating policy reserves.

Sex-distinct mortality table also known as gender-based mortality table, which shows different mortality rates for males and females at each age.

It shows that women basically experience lower mortality at all ages than men do.

Unisex mortality table which shows for each age a single set of mortality rates for both males & females.

The type of mortality table chosen for a particular application depends upon

• Product type involved
• Purpose of  a given calculation
• The population being studied
• The availability of statistics from various sources.

The Loading Charge

Purpose of loading charge is to

• Defray the company’s operating expenses
• Compensate the insurer for a loss of premium
• Provide a financial safety margin against unexpected outcomes
• Provide a financial safety margin that can fund a policy dividend for participating products.

Operating Expenses

Are the expenses that arise in the normal course of a life insurer’s business operations? Insurers typically classify operating costs into

Acquisition Expenses are the insurer’s expenses to obtaining and issuing new insurance or annuity business.

Development expenses are the costs associated with planning and creating insurance products. These costs include the salaries of employees involved in product devt., computer resources and research.

Maintenance Expenses also known as renewal expenses are the costs of keeping policies in force. Example of maintenance expenses include renewal commissions, premium taxes.

Overhead expenses are costs incurred during normal business operations that are not directly connected to a specific product or service. Examples of overhead costs include the costs of furniture and fixtures, telephone service, electricity etc.

Provision for Policy Lapses

The loading charge also compensates the insurer for policy loans.

The lapse rate is the percentage of an insurer’s business in force at the beginning of a specified period.

The persistency rate is the percentage of an insurer’s business in force at the beginning of a specified period that remains in force at the end of the period.       

Bundled & Unbundled Pricing

Bundled Pricing is a pricing structure in which the insurer presents the product as a package of benefits provided to customers in exchange for a specified monetary amount.

Unbundled Pricing is a pricing structure in which the insurer explicitly discloses to customers the breakdown of the various benefit and loading charges and the rate of investment return being credited.

Bundled Pricing For Life Insurance The Loading charge, cost of benefits, and investment earnings can be combined into a simple formula for a life insurance gross premium, which is

            Life insurance gross premium = Loading Charge + Charge for Cost of benefits - Provision for investment earnings

            Life insurance net premium =  Charge for Cost of benefits - Provision for investment earnings

Bundled Pricing for Annuities

For a bundled annuity in the payout period, the insurer develops an annuity cost, which is the value of future periodic payments; adjust for the time value of money, under an annuity policy.

            Net annuity cost, life annuity + Loading Charge = Gross annuity cost, life annuity

Policy Reserves & Cash Values

Cash Value = Actuarially adjusted value of future benefits - Actuarially adjusted value of future gross premium

Reserve = Actuarially adjusted value of future benefits - Actuarially adjusted value of future net premium

Profit-Testing Actuarial Assumptions

Before finalizing a product’s pricing, the actuary uses asset-share model.

Asset-Share model is a mathematical simulation model used to illustrate how an insurance product’s assets, liabilities and surplus would change from year to year under given sets of assumptions. It indicates

·         The point in time when an insurer can expect a product to become profitable.

·         The amount of money the company will collect each year in premiums & investment earnings.

·         The amount of expected expenses.

·         The yearly increase in company surplus from the given product.

·         The yearly increase in policy reserves, cash values and asset shares.

An Asset share is the net amount of cash that an insurance product has accumulated per unit of product at a given time.

Break-even point also called the validation point is the pointing time when a product’s asset share first equals its policy reserve.

Break-even period also called the validation period, is the time period beginning when a product is issued and ending when the product’s asset share grows to equal its reserve.

Margins, costs, and other values can be actual, assumed, or expected.

Actual value is historical value that is known from experience.

Assumed value is any value for an unknown future quantity that is built into pricing.

Expected value is any value for an unknown future quantity that an insurer’s actuaries believe is most likely to occur.

A difference between actual value & assumed value is known as deviation.

Favorable Deviation is a condition in which the difference between actual and assumed product values produces actual product profitability that is higher than the assumed profitability. It occurs when

·         Actual company revenue is higher than assumed

·         Actual benefit payments is lower than assumed

·         Actual company expenses is lower than assumed

·         Actual policy lapses is lower than assumed

Adverse Deviation is a condition in which the difference between actual and assumed product values produces actual product profitability that is lower than the assumed profitability. It occurs when

·         Actual company revenue is lower than assumed

·         Actual benefit payments is higher than assumed

·         Actual company expenses is higher than assumed

·         Actual policy lapses is higher than assumed

Corrective actions include

·         Revising the premium rate structure

·         Reducing the dividend scale

·         Improving operating efficiencies

Withdrawing the product from the market.