chapter culc
DESCRIPTION
Actuarial PracticeTRANSCRIPT
INVESTMENT LINKED CONTRACT
INTRODUCTION
INVESTMENT-LINKED/UNIT LINKED CONTRACTS
A policy where the benefits are linked directly to the investment performance of a specified fund, and characterized by a lower level of guarantees on benefits and premiums
INTRODUCTION
Describe the type of benefit provided by a unit-linked contract.
INTRODUCTION
The key features of a unit-linked contract are:
• The policyholder’s premium is paid into an investment fund and at that time buys a number of “units”, which represents a share of that fund
• The insurance company will deduct charges from the policyholder’s fund. These may be deducted from the premiums before they are invested.
• Charges may also be deducted from the unit funds.
• The value of the policy at maturity is usually the (bid) value of units.
INTRODUCTION
The key features of a unit-linked contract are:
• A surrender penalty may be deducted from the value of the units if the policyholder withdraws from the contract.
• The charges are kept by the insurer to cover expenses and risk benefits. The insurer will aim for charges to exceed expenses and insurance benefits, to give profit to the insurer.
OPERATIONS OF THE FUND
Figure 1: The operation of a unit-linked fund
OPERATIONS OF THE FUND
The distinction between the unit and non-unit funds:
• The (bid) value of the policyholder’s unit fund at any point in time is the amount of money that the company would pay to the policyholder on a claim under the policy. This might be on death, on the maturity of an endowment, or on surrender.
• Hence the unit fund defines the policyholder’s (basic) benefit, and the company has a liability to pay this amount (whatever it should be) at the time of claim.
OPERATIONS OF THE FUND
The distinction between the unit and non-unit funds:
• The non-unit funds is simply the company’s cash.
• Essentially similar to the nonprofit fund under conventional nonprofit contracts
• The cost of insurance benefits and of expenses are deducted from this fund, as well as the balance accumulating as profit (or loss) for the shareholders and/or the with-profits policyholders.
Unit Fund
• The unit fund can be considered as the sum of the contractual shares under all of the policies currently in force.
• The shares are determined by a system of unit allocation.• Each policyholder is allocated a number of units of the fund whenever a
premium is paid.• Each unit is equal value at any particular date, but the value (or price) of a
unit will vary over time, reflecting the value of the underlying assets at any particular time.
• The units will also have two prices on any particular date:- The price at which they can be purchased, the offer price- The price at which they can be sold, the bid price
Unit Fund
Bid and offer price:-
• most life companies use the bid/offer spread to help cover expenses and contribute to profit.
• The policyholder buys unit with premium at the offer price.
• At maturity the company buys those units back from the policyholder at the bid price.
• The bid price will typically be 5% lower than the offer price.
Unit Fund
• A policyholder will be allocated the following number of units on the payment of premium:
Amount of premium allocated Offer price of one unit
which will be added to the total of his or her existing units.
• At any future time, t, the policyholder’s contractual share will equalUt = (Total number of units allocated to policyholder) x (bid price of one unit)
Unit Fund
What is the difference between charges and actual cost? And what are they?
Unit Fund
The operation of the funds is in accordance with the following formula (amounts per policy):
For Unit Fund
WhereUt – the bid-value of unit fund at the end of year ta and b – the allocation rate and bid-offer spread respectively (paid in year t)Pt , Zt , mt – amounts of premium , expense charge and mortality charge respectively (paid in year t)it
u – the rate of investment return earned by the unit fund during year t.fmct – fund management charge paid in year t
Unit Fund
The operation of the funds is in accordance with the following formula (amounts per policy):
For non-unit cash flow
Whereet
z , etfm – the amounts of administration and fund management expenses incurred
during year tit
n – the rate of investment return earned by the non-unit fund during year t.ct – the expected (average) cost of claims from the non-unit fund during year t.
Example
Contract : 10-year unit-linked endowment assuranceAnnual Premiums : RM1,500 Allocation premium : 97% throughoutBid/offer Spread : 5%Benefit : Death benefit of RM40,000 or the bid value of the units whichever is higher, is payable at the end of the year of death.Fund Management Charge : 1% of the bid value of the unitsCost of Cover : As ChargedMortality Rate : 70% of AM92 UltimatePolicy Fee : RM 50Unit Growth : 12.3% of Mixed Funds, per year. (Subject to the shares volatility)
Example
Question 1:Calculate the unit fund at the end of the first month of the policy (deducting all charges at the end of the month) for a 40-year old policyholder.
Question 2:Suppose that the company’s expenses in respect of this policy in the first month were 55% of annual premium plus £178, and that on average the mortality experience of all such policyholders was 58% of AM92 Ultimate. Calculate the profit or loss to the company for that first month (ignoring the impact of interest on the non-unit fund).
Case Study
Contract : 5-years Unit-Linked EndowmentDeath Benefit : Higher of RM 10,000 or bid-value of unitsAnnual Premium : RM 300Allocation Premium : 100% throughoutBid Offer Spread : 5%Mortality Rates:Year 1 – 0.00277Year 2 – 0.00310Year 3 – 0.00347Year 4 – 0.00391Year 5 – 0.00440Fund Management Charge : 0.5% of the bid value of the units
Case Study
Expenses :Year 1 – RM 220Year 2 – RM 22.9Year 3 – RM 23.8Year 4 – RM 24.8Year 5 – RM 25.7Experience AssumptionsMortality Rates :Year 1 – 0.00251Year 2 – 0.00281Year 3 – 0.00315Year 4 – 0.00354Year 5 – 0.00398
Case Study
Maintenance Expenses :Assumed inccured at the start of the yearYear 1 – RM 200Year 2 – RM 20.8Year 3 – RM 21.6Year 4 – RM 22.5Year 5 – RM 23.4Investment Management Expenses : 0.35% of the bid-value of units incurred at the end of each yearRates of return on assets:Unit fund: 10% p.aNon Unit Fund : 6% p.a
Case Study
Questions:
1. Calculate the unit fund at end of year after fund charge for Year 1- Year 5 based on the assumptions given.
2. Calculate the per-policy non-unit cash flows, per policy in force for Year 1 – Year 5.