Chapter 10: CONTRACT DESIGN

1. Parties Involved:
 Client and Customer
 Other stakeholders

2. Risk appetite of customers

3. Benefits offered:
 Type of benefit and Form of benefit
 Options & Guarantees
 Discontinuance benefits
 Discretionary benefits
 Terms and conditions

4. Commercial Considerations
 Profitability
 Marketability
 Competitors
 Regulation

5. Financing Considerations
 Financing requirements (capital requirements)
 Method of financing benefits

6. Premiums/Contributions & Charges

 Premium
 Expenses vs. Charges

7. Admin & Accounting

 Admin systems
 Accounting implications

8. Considering other products:

 Cross subsidies
 Consistency with other products
 Parties Involved
 Client & Customer needs

Client needs Customer needs

Chosen Market (demographic and economic Premium ready to pay
composition of customers)
General economic & commercial environment Benefits required in future
(legislation, tax, accounting standards, competition)
Capital available (affects type of product chosen) Attitude to financial risk
Expertise available Understanding of the product

 Other Stakeholders
 Actuaries: Initial costing, Provisions, Pricing / Rating + Hiring of new staff

 Reinsurer: Type of arrangement, costs of reinsurance, take expert advice

 Lawyers:
 Drafting of contracts
 Fraudulent case management

 Accountants: Cash flow (income and outgo)

 Management team: Balance sales (commission costs) , customer and s/h expectations

 Financial Backers (providers of finance to design the contract)

 Would need reports regarding utilization of finances

 Administrators
 Administrate complexity of financial structures
 Check for errors and do error correction

 Claim management team (identifying fraud – check all conditions are fulfilled)

 Underwriting team: Setting up underwriting standards

 Sales and Marketing

 Sales: Selling of contract (need proper training; training costs can be high)
 Operations team (call center executives): How to deal with customers
 Marketing: Identify target market / Advertisement

 Any TPAs (outsourcing claim management)

 Risk Appetite

 Risk appetite of customer should be matched with the risk profile of the contract
 Can offer various investment choices for saving type contracts
Risk adverse individual: will invest in short dated bonds & blue chip equity companies
Risk lover individual: will invest in equities of unquoted companies, in emerging markets
and in high risk companies & industries

Deciding on benefits to offer

 Level and Form of benefits

 Level – Amount of benefit (fixed or inflation linked)

 Form – Regular or one off & Monetary or non-monetary (e.g. goods and services)
 Cashless service (or need to make upfront payments and then claim later on)
 Including any deductibles / copays

 Options and Guarantees

 Options: There could be options included in the contract with respect to the following:

 Frequency of payment
 Waiver of pm. / contribution
PAYMENT OF PREMIUMS {in cases of sickness, accident or unemployment)
 Option of paid up additional / paid up premium
 Early, Late or Ill health retirement
 Tax free cash lump sum
BENEFITS  Discontinuance or Transfer options
 No claims discount
 Spouse / Dependent’s benefits
 Option to add rider benefit (in TA contract)
 Option to choose between out-network and in-network
USING CONTRACT hospitals
PROCEEDS  Option in DC pension scheme: buying annuity with
scheme sponsor or with any other provider
CONVERTIBILITY /  Option to renew without further underwriting
RENEWABILITY  Option to convert TA into Endowment / Whole life
REVIEWABILITY  Reviewing the premiums
  Guarantees:
 Guaranteed benefits for minimum period (annuities)
 Guaranteed sum assured (for with profit / unit linked contracts)

 Discretionary benefits
 Life Insurance: WP contracts
 General Insurance: No claim discount (motor insurance)
 Pensions: Discretionary pension increases in final salary schemes

 Discontinuance

 The discontinuance terms should be fair to p/h

 Option of discontinuance makes policy more marketable but more complex to
administer

 Terms and Conditions

 Contract should have no loopholes.

 Clear definitions (no ambiguity)
 Easy and simple wording
 Clause of reviewing charges / benefits / guarantees should be clearly stated
 Exclusions should be clearly defined

Commercial Considerations
 Profitability
1. Claims experience (includes mortality / morbidity experience)
 Claims frequency
 Claims severity
 Claims inflation
 Claims volatility

2. Expenses & Expense inflation

3. Investment returns
4. Withdrawal experience
5. New Business sales and Business mix
6. Tax rates
7. Reinsurance premium rates
8. Provisions
9. Cost of Options and Guarantees

 Marketability
 Innovated product or a Standard product
 Simplicity
 Options and Guarantees
 Disclosure of all relevant information
 Low charges

 Competitiveness
 Standardized products would be more competitive in the market (as the products would
be comparable with other providers)
E.g. T.A, Whole life, Annuities, Motor Insurance
 Complex products and / or products in which benefits have an investment component
would be less competitive
E.g. Long term care, Unit linked, With-profit

 Regulation
  Solvency / Capital requirements
 Premium rates (minimum or maximum) / Premium reviewability
 Distribution channels
 Level of Underwriting (restrictions on exclusions)
 Investment restriction
 Options / Guarantees

Financing Considerations

 Financing requirements
 Required because of new business strain (sum of initial expenses, initial commission
paid and initial increase in provisions is greater than the premium received in 1st year)
 Expected volume of business
 Capital available
 Any other product / business

 Method of Financing benefits

 Pay as you go
 Accumulate all funds in advance
 Regular payments building up a fund
 Terminal Funding

Premiums/Contributions & Charges

 Premium / Contributions
 Premium or Contribution flexibility can increase marketability/competitiveness of the
product, but it will make it more expensive to administer

Premium should be charged according to:

 How much is guaranteed
 Term of contract
 Volume of business
 Capital available
 Any suitable Investments to hedge
 Level of provisions required

 Charges vs. Expenses

 Charges: Income to provider(this is taken from customer & it may include profit loading)
 Expenses: Outflow for provider

COSTS CHARGES

Designing costs Initial charge / Percent of premiums

Advertising / Sales “
Commission: Initial “
Renewal Ongoing charge / Percent of premiums or funds
Management of assets Regular charge / Percent of funds

Profitability to provider Regular charge, Loadings on above charges

Overhead (IT, rental) “

Admin: Initial Initial charge / Fixed Amt.

Ongoing Ongoing charge (increasing in line with inflation) / Fixed Amt.
Termination Termination charges, Reduction in benefits, Fixed Amt.

Administrative and Accounting Issues

 Administration systems

 Design should be such that the administration team & computer system can manage the
product
 Data storage systems

 Accounting Issues

 Proper accounting of all cash flows

Other Products

 Cross subsidies

 Within a contract: Large Policies contributing more towards profits and expenses than
smaller policies. Hence, Larger Policies subsidize smaller policies
 Other contracts

 Consistency with other Products

 Consistency in designing and pricing with existing contracts

If there is no consistency, then construction of new designs and pricing techniques would be
time consuming and expensive.
Increase in costs due to:
 Training Staff / Admin for understanding design of contract
 Changes in marketing strategy
 New model development and Data collection for pricing methods
If the new contract is more attractive than existing contracts, then it would seem UNFAIR to
existing customers, hence leading to dissatisfaction and business risk.

USING SIMPLE LANGUAGE & NOT LEGAL LANGUAGE IN POLICY DESIGN

Most customers find insurance contracts with its T’s & C’s, options and guarantees, exclusion
clauses fairly difficult to understand, more so if it is in complex legal language.

Using Simple Language:

 Easy and a simple way to communicate policy terms and conditions
 Easy to make customers understand the policy and appreciate its benefits
 Enhance customer friendly image
 Persistency rates higher (PREs are met) / More renewals
 Understanding of claim processes would be simpler
 Less claim delays (as more clarity in interpretation of validity of claims)
 Less claim underwriting (underwriting costs saved)
 Less customer enquiries (service costs saved)
 Makes it different from competitor products (sales may go up)
 Appreciated by regulator to be fair to customer

REDUCTION OF NEW BUSINESS STRAIN

 Large Premium initially or getting a single premium
 Lower expenses

 Commissions:
 Pay renewal commission rather than initial commission
 Change distribution channels to reduce commissions (e.g. sell directly)
 Reduce commission paid

 Charges
 Charges matching expenses (have variable charges / premiums)
 Have a large initial charge (e.g. for unit linked products)

 Assigning lower initial provisions

 Use financial reinsurance
 Put a cap on volume of business
 Change from a without profit to a unit linked product
 Lower cost of guarantees

Disadvantages of having single premium instead of regular premiums

 Less people ready to pay single premium (only high income individuals willing to do so)
 Regular premium: more affordable and hence increase sales volume for the company
especially if its distribution channels cater to low income groups.
Regular premium with monthly mode can help the customer to pay premiums by way of
deduction from salary (more convenient for customer)

 Purchasers of single premium policy might expect some surrender value to be paid in the
initial years. Surrender value may be perceived as unattractive.

 In comparing the market share, analysts may not give full value to single premium
policies but instead give limited credit

 Regular premium policies provide frequent opportunities for interaction with customer. A
satisfied customer is also a “repeat customer”.

 Regular premium policies may be perceived as providing higher value as the SA will be
larger multiple of annual regular premium than a single premium policy.

Advantages of having single premium instead of regular premiums

 Regular premium policies are exposed to risk of lapse and re‐entry especially if the term
market is highly competitive. Risk of lapse is less for single premium policies.

 It is unlikely that single premium polices offer surrender benefits and hence risk of
selective surrender and entry is reduced.

 New Business Strain will be lower

 The operational cost of managing a regular premium policy is higher.

Renewal notices to customers, premiums collections, records updating

 A single premium policy will be preferred by customers who are looking to purchase
term insurance to cover mortgage or other loans.

 Uncertainty over future premium taxes in regular pay policies compared to single pay

 There is possibility of having high commission rate in regular premium than single and
hence higher price for customer.

Result of changes in distribution channels (from sales force to internet)

1. Mortality

 Change in target market

 Sales force more a “push sale” than internet channel which is a
sale based on need
 Underwriting and Claims process – Internet sale requires
simplified UW and issuance process which will result in different
claims experience.

2. Expenses

 Sales force expenses: Premises / salary /commission.

 Internet sale will not involve huge people costs but expenses in
terms of advertising, propagation of internet sales, one-time cost
of admin change

3. Persistency

 Internet sales can also propagate issues like bank account debit
of premium payments which might improve persistency and
have different cost implications

4. Claim size

 Average case size will be different- due to simplified UW process

in internet it might not be possible to offer large SA
Changing to internet based distribution channel

Online channel sales may diversify the customer base, but there are several risks:

1. Increased potential for anti‐selection.

2. Fewer health questions are asked so mortality is expected to be higher than for other
channels

3. Internet usage is higher amongst younger people, hence average age may be lower.
Hence mortality risk may increase.

4. Younger people may have a higher propensity to lapse their policy due to lack of steady
income, greater propensity to change providers if they find a more competitive product

5. No salesman is involved, which may increase lapses for this channel.

6. Without the existence of face‐to‐face advice, there may be a tendency for people to
underinsure themselves by paying smaller premiums & hence get low SA

7. There are likely to be considerable development costs which will need to be recouped

8. Premium rates will be comparable over the net and hence price has to be competitive
/frequently reviewed to be relevant in the market.

9. IT costs: admin changes online, marketing costs, changes in storage of information

10. IT loading up speed slows down impacting customer experience and sales

11. Issues relating to data security & protection of customer details like credit card details