Download Institute of Actuaries of India Subject CA3 – Communications INDICATIVE SOLUTION

Institute of Actuaries of India
Subject CA3 – Communications
May 2008 Examination
INDICATIVE SOLUTION
Introduction
The indicative solution has been written by the Examiners with the aim of helping
candidates. The solutions given are only indicative. It is realized that there could be other
points as valid answers and examiner have given credit for any alternative approach or
interpretation which they consider to be reasonable.
CA3
0508
Indicative Solution: Question 1
New Market Opportunities in XYZ
Presentation by the Strategy and Research Department
15 May 2008
Contents
•
•
•
•
Macro-economic overview
Regulatory overview
Products and their performance
Summary
2
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CA3
0508
Macro-economic overview
•
•
•
•
XYZ – an emerging country
GDP growth of 6.1% over the last five years
GDP per capita increased 4.7% over the same period
Inflation averaging 5.6%, above the inflation target of 4%
Economic Trends
2,600
10.0%
9.0%
2,500
8.0%
2,400
7.0%
2,300
6.0%
5.0%
2,200
4.0%
2,100
3.0%
2,000
2.0%
GDP per capita
GDP growth
1,900
1.0%
0.0%
1,800
2003
2004
2005
2006
2007
3
Insurance Regulatory Overview
•
•
•
•
Regulatory environment evolving but progressive
Appointed actuary system adopted in life insurance in 2006
Pricing of life insurance products restricted by prescribed maximum
interest rates
Motor and home insurance products under tariff – other products are free
from tariff
Fiscal policy
• Life insurance premiums are tax deductible, subject to an annual limit.
o 2007 limit was Rs595
o Limit has grown at 4.7% over the last five years
• Maturity or surrender values attract tax at 20% on the gains
• No tax incentives on general insurance products
4
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0508
ƒ
Insurance Industry Statistics
•
•
•
Industry growth of 40% CAGR over the last five years
Life industry grew 42% while the general insurance industry grew 34%
Life insurance contributed towards 80% of the total industry premium,
up from 76% in 2003
Insurance Premium
4500
4000
808
Rs million
3500
General insurance
3000
Life insurance
2500
635
584
3232
2000
412
1500
1000
257
500
814
2071
2389
1381
0
2003
2004
2005
2006
2007
5
Insurance Industry Statistics (2)
•
•
Insurance penetration has gone up to 2.0% of GDP in 2007 from 0.7% in
2003
Insurance premium per capita has increased to 50 in 2007 from 14 in
2003
Penetration and Insurance Per Capita
2.5%
60.0
50.0
2.0%
40.0
1.5%
Insurance Penetration (LHS)
1.0%
Insurance per capita (RHS)
0.5%
30.0
20.0
10.0
0.0%
2003
2004
2005
2006
2007
6
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0508
Products – Life Insurance
•
Limited range of products sold
Endowment
Whole of Life
Term Assurance
o
o
o
•
Unit-linked products not yet authorized – expected c2010
Life Insurance Products
3,500
3,000
Rs million
30%
Whole of Life
Term Assurance
Endowment
2,500
2,000
29%
28%
1,500
27%
1,000
500
-
26%
31%
43%
32%
2003
2004
41%
33%
35%
34%
39%
37%
2005
2006
35%
2007
7
Product Profitability – Life Insurance
•
•
•
•
Profitability measured by return on equity (ROE)
Term assurance highly profitable, but variable over the last 5 years
Endowment ROE stable around 12% - 13%
Whole of Life least profitable with declining ROE
Return on Equity
35.0%
30.0%
25.0%
Endowment
Term Assurance
Whole of Life
20.0%
15.0%
10.0%
5.0%
0.0%
2003
2004
2005
2006
2007
8
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CA3
0508
Products – General Insurance
•
•
•
Motor and home insurance under tariff
o Resistance against motor de-tariffication
Fire, Product & Liability business de-tariffed
Fire losing share to Home and Product & Liability product lines
General Insurance Products
900
800
Product & Liability
Fire
Home
Motor
Rs million
700
600
500
400
17%
300
31%
200
100
-
16%
20%
18%
29%
19%
27%
13%
14%
40%
40%
2005
2006
12%
33%
11%
40%
40%
2003
2004
25%
15%
40%
2007
9
Product Profitability – General Insurance
•
•
•
Motor hugely loss making (with 40% of the market)
Fire losing share and witnessing higher losses
Product & Liability highly profitable and stable
Loss Ratio
160%
140%
120%
100%
80%
60%
Motor
Home
Fire
Product & Liability
40%
20%
0%
2003
2004
2005
2006
2007
10
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0508
Summary
•
XYZ’s insurance market is evolving rapidly
•
Very strong insurance growth of 40% over the last 5 years
•
Several regulatory constraints:
o Unit-linked products not allowed
o Motor and home product under tariff
o Pricing restrictions on life insurance products
•
Term assurance highly profitable and gaining share
•
Endowment and Whole of Life considerably less profitable
•
Tariff products less profitable, although showing recent improvements
11
(Marks 60)
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CA3
0508
Indicative Solution: Question 2
Dear John,
Market value of insurance liabilities
It is very difficult to calculate the market value of insurance liabilities as there is no
market where these liabilities are bought and sold. So unlike say a share which is listed
on the stock exchange you cannot look up the market value in a newspaper or on a
market trading screen.
Therefore as there is no regular market insurance companies have to calculate the market
value from in-house financial models. These models are very complex in nature and
many assumptions go into the model. Important assumptions are those regarding how
volatile asset values are, death rates of policyholders, expenses of the insurer, and the rate
at which policyholders surrender their policies. As the insurer is trying to calculate a
market value, assumptions should always be based on market data where such data is
available. For example, the extent to which the market assumes asset values can vary can
be worked out from market prices of derivative instruments.
Insurance contracts are difficult to value particularly those which offer guarantees to the
policyholder (e.g. a promise of a minimum 3% return on the premiums invested) and/or
give the policyholder certain rights (e.g. right to a guaranteed minimum surrender value).
For contracts with such features there is no formula approach that gives the correct
answer. Therefore for such contracts the insurer has to run thousands of so-called “market
–consistent” simulations of the model to calculate the liability.
The above simulations need to capture how the various factors relate to each other with
for example the rate at which policyholders are assumed to surrender often being linked
to the prevailing economic conditions. It is very important to have this linkage in the case
of policies which offer guarantees to the policyholder. For example, if the policy
guarantees a 7% return and interest rates have fallen to 3% more policyholders may keep
their policy going which increases the insurance company’s ultimate liability as the
insurer has to pay the policyholders 7% when it can earn only 3% from the market.
Each simulation gives a value for the liability. The average of these forms what is called
the best estimate liability. This is not the same as the market value of liabilities though.
This is because if the company were to sell the liabilities on to another company the
buying company would also have to hold capital to back the liabilities. The need to hold
capital arises as no matter what assets the purchasing company invests in it will still be
subject to certain risks (e.g. policyholders surrendering their policies at different rates to
that assumed). The buying company therefore needs to hold capital to support these risks.
Holding capital however has a cost and therefore we need to add on to the best estimate
liability the cost of holding capital to derive the market value of liabilities.
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0508
When insurance companies carry out this work it is important to be careful in the choice
of assumptions. This is because the market value of liabilities can often be sensitive to the
assumptions made about how often and to what extent adverse events take place. This is
particularly so for policies providing options and guarantees to the policyholder. Recent
events in the global financial markets have shown that such adverse events often occur
more frequently than models have assumed and also that the extent of the downturn is
often worse than that assumed in the model. Therefore one has to examine this aspect
very carefully.
I trust the above clarifies the various queries you had regarding the market value of
insurance liabilities.
Regards
Frank
(Marks 40)
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