pricing strategy product insurance

Pricing Insurance ProductsPricing Insurance Products

LOMA 290

Insurance Company Operations

LOMA 290

Insurance Company Operations

LESSON 7LESSON 7

LESSON SEVEN 1© 2005 LOMA All Rights Reserved

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Lesson 7

Pricing StrategiesPricing usually involves (1) selecting product pricing objectives and strategy, (2) profit-testing actuarial assumptions, and (3) managing pricing results.

Pricing strategies for life insurance premiums: Cost-driven pricing: sets premiums at a level that will cover

the company’s costs to create, offer, and administer the product, and also allow a modest profit.

Competition-driven pricing: sets premiums in reference to those set by competitors for similar products

Customer-driven pricing: sets premiums that a company’s customers will accept

Pricing objective: a goal that specifies what a company wants to achieve with a product’s pricing in terms of desired profits, sales, and market share

Product strategy: a general guideline for using a product’s financial features as a variable in the marketing mix


Lesson 7

Actuarial Assumptions

Investment earnings, represented by the interest rate

Cost of benefits

Loading: the portion of a product’s pricing structure

designed to reimburse the insurer for its operating

expenses and other factors

Insurers use mathematical models to measure several profitability standards. Actuaries enter actuarial assumptions—assumed values—for each product’s important pricing components:


Lesson 7

Investment Earningsand Interest Rates

net investment income: the excess of investment income over investment expenses, including management fees, transactions fees, and administrative expenses

time value of money: the concept that the value of a sum of money will change over time due to the effect of interest

While all other factors remain constant, if the

- interest rate increases, then the value of the sum invested will increase

- interest rate decreases, then the value of the sum invested will decrease

- growth period lengthens, then the value of the sum invested will increase

- growth period shortens, then the value of the sum invested will decrease


Lesson 7

Cost of Benefitsand the Mortality Factor

mortality rate: the rate at which death occurs among a defined group of people during a specified period, typically one year

Cost of benefits for life insurance products(cost of insurance) = Death benefit × Mortality rate

Generally, the higher the mortality rate, the higher the benefit cost and the higher the premiums for life insurance.


Lesson 7

Cost of Benefitsand the Mortality FactorCost of benefits for an annuity is affected by the type of annuity and the payout option selected.

During the payout period, the

Cost of annuity benefits for the year =Annual income payment × Probability of annuitant’s

survival to the next year

Higher mortality rates generally are associated with shorter life spans. The higher the mortality rate for a group of life annuitants, the lower the benefit cost.


Lesson 7

Mortality Table Calculations

Actuaries gather and maintain mortality statistics from various sources, including the insurer’s mortality experience: the number or rate of deaths that actually occurred in a given group of people during a given year

Actuaries gather and maintain mortality statistics from various sources, including the insurer’s mortality experience: the number or rate of deaths that actually occurred in a given group of people during a given year

Statistics are then combined from many insurers into a mortality table: a chart that shows the projected death rates among a particular group at each age—that is, how many people in each age group may be expected to die at a given age

Statistics are then combined from many insurers into a mortality table: a chart that shows the projected death rates among a particular group at each age—that is, how many people in each age group may be expected to die at a given age


Lesson 7

Mortality Table Calculations

Number living, age 71 =Number living, age 70 – Number dying, age 70 =

100,000 – 1,100 = 98,900

Number living, age 71 =Number living, age 70 – Number dying, age 70 =

100,000 – 1,100 = 98,900

Multiply the mortality rate by 1,000 to express the mortality rate per 1,000 lives.

Number dying, age 71Number living, age 71

Number dying, age 71Number living, age 71 =

1,18798,900 = 0.012Mortality rate =

Click on table to link to a full mortality table in Excel.


Lesson 7

Mortality Tables and Data

Common types of mortality tables include:

Annuity mortality table: lower mortality rates than life insurance mortality table

Life insurance mortality table: higher mortality rates than annuity mortality table

Basic mortality table: no safety margin;used for pricing

Valuation mortality table: safety margin;used for reserves

Sex-distinct mortality table: women live longer than men

Unisex mortality table: required in a few jurisdictions

Annuity mortality table: lower mortality rates than life insurance mortality table

Life insurance mortality table: higher mortality rates than annuity mortality table

Basic mortality table: no safety margin;used for pricing

Valuation mortality table: safety margin;used for reserves

Sex-distinct mortality table: women live longer than men

Unisex mortality table: required in a few jurisdictions


Lesson 7

Insurance Product Expenses

The loading charge in insurance products:

Defrays the insurer’s operating expenses Compensates the insurer for loss of premium

income from policy lapses Provides a financial safety margin against

unexpected outcomes from actuarial assumptions Provides a safety margin that can fund policy

dividends for participating products


Lesson 7

Insurance Product Expenses

Operating expenses are costs, other than benefit costs, that arise in the normal course of insurance company operations.

Development expenses: associated with planning and creating insurance products

Acquisition expenses: related to obtaining and issuing new business

Maintenance expenses: associated with keeping policies in force

Overhead expenses: incurred during normal business operations, but not directly connected to a specific product or service (e.g., electricity cost)


Lesson 7

Policy Lapses

A policy lapse occurs when a policyowner terminates a contract by failing to pay sufficient premiums during a specified period.

Lapse rate: the percentage of an insurer’s business in force at the beginning of a specified period—such as a year—that lapses by the end of the period

Subtracting the lapse rate from 100 percent yields the persistency rate: 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.


Lesson 7

Safety MarginsInsurers use safety margins in product pricing to:

Defray unexpected losses due to unfavorable contingencies Contribute to profit Contribute to policy dividends for participating policies

Contingencies are exposures to risk. Contingencies that can cause negative outcomes for pricing include:

Severe swings in market interest rates

Unfavorable mortality experience

Unfavorable deviations from expense assumptions

Unfavorable regulatory decisions

Unfavorable tax legislation


Lesson 7

Bundled and Unbundled Pricing

Both life insurance and annuity products may have a bundled or unbundled pricing structure. Bundled pricing is common for older product types such as whole life insurance and fixed annuities.

bundled pricing: the insurer presents the product as a package of benefits tocustomers in exchange for a specified monetary amount

bundled pricing: the insurer presents the product as a package of benefits tocustomers in exchange for a specified monetary amount

unbundled pricing: the insurer explicitly discloses to customers the breakdown of various benefits and loading charges and the investment return rate being credited

unbundled pricing: the insurer explicitly discloses to customers the breakdown of various benefits and loading charges and the investment return rate being credited


Lesson 7

Bundled Pricing

life insurance gross premium: the amount the customer pays to purchase the policy

Life insurance gross premium =Loading charge + Charge for cost of benefits – Provision for

investment earnings

life insurance net premium: the charge for policy benefits, based on mortality assumptions and interest assumptions but without a provision for loading

Life insurance net premium =Charge for cost of benefits – Provision for investment earnings

life insurance gross premium: the amount the customer pays to purchase the policy

Life insurance gross premium =Loading charge + Charge for cost of benefits – Provision for

investment earnings

life insurance net premium: the charge for policy benefits, based on mortality assumptions and interest assumptions but without a provision for loading

Life insurance net premium =Charge for cost of benefits – Provision for investment earnings

Deferred annuities usually have an unbundled pricing structure during the accumulation period. For a bundled annuity in the payout period, the annuity cost is the value of future periodic payments, adjusted for the time value of money.

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

Deferred annuities usually have an unbundled pricing structure during the accumulation period. For a bundled annuity in the payout period, the annuity cost is the value of future periodic payments, adjusted for the time value of money.

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


Lesson 7

Policy Reserves and Cash Values

A product’s pricing must also provide for a policy reserve and cash value. Reserve requirements in the United States specify that an insurer must maintain minimum policy reserves, based on those calculated using specific mortality tables, interest rates, and other factors.

cash value: the amount of money before adjustments that a policyowner will receive if the policy lapses or is surrendered

cash value: the amount of money before adjustments that a policyowner will receive if the policy lapses or is surrendered


Lesson 7

Policy Reserves and Cash Values

Reserves and cash values are both based on conservative actuarial assumptions. The cash value and the reserve are similar in amount. A cash value provides for loading; a reserve does not.

Cash value (life insurance) =Actuarially adjusted value of future benefits –

Actuarially adjusted value of future gross premium

Cash value (life insurance) =Actuarially adjusted value of future benefits –

Actuarially adjusted value of future gross premium

Reserve (life insurance) =Actuarially adjusted value of future benefits –

Actuarially adjusted value of future net premium

Reserve (life insurance) =Actuarially adjusted value of future benefits –

Actuarially adjusted value of future net premium


Lesson 7

Profit-TestingActuarial Assumptions

asset-share model: 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

asset-share model: 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

asset share: the net amount of cash that an insurance product has accumulated per unit of product at a given time

asset share: the net amount of cash that an insurance product has accumulated per unit of product at a given time


Lesson 7

Profit-TestingActuarial Assumptions

break-even point: the point when a product’s asset share first equals or exceeds its policy reserve and the product becomes profitable

break-even point: the point when a product’s asset share first equals or exceeds its policy reserve and the product becomes profitable

break-even period: the amount of time it takes after issue for a product to reach its break-even point and become profitable; in other words, when the product’s asset share equals its reserve

break-even period: the amount of time it takes after issue for a product to reach its break-even point and become profitable; in other words, when the product’s asset share equals its reserve

Product actuaries can change actuarial assumptions if the break-even period for a new product is too long. Changes must be actuarially sound.


Lesson 7

Managing Pricing ResultsA product’s financial structure reflects a set of actuarial assumptions. Margins, costs, and other values can be actual, assumed, or expected.

Actual value: a historical value that is known from experience, such as a value that emerges after a product has been in force

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

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


Lesson 7

Managing Pricing ResultsAfter a product has been in force, actuaries can compare actual values against the actuarial assumptions used in pricing the product. Favorable deviation: the difference between actual and assumed

values produces actual product profitability that is higher than assumed product profitability

Adverse deviation: the difference between actual and assumed values produces actual product profitability that is lower than assumed product profitability

Corrective actions to take if significant adverse deviations occur: Revise the premium rate structure for future products Reduce the dividend scale for participating policies Improve operating efficiencies to reduce actual expenses Withdraw a product from the market Modify an existing product


Lesson 7

End of Lesson 7

pricing strategy product insurance

Documents

mortality statistics

mortality factormortality

main menu lesson

death benefit mortality

lower mortality rates

men unisex mortality

insurers mortality experience

year higher mortality