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Meeting the Clients Needs: Good Product Design

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The Heart of the Matter. Good (financial) product design resolves the tension ... of severity is often on scale 1 to 5 with 1=minor loss; 5=unbearable loss ... – PowerPoint PPT presentation

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Title: Meeting the Clients Needs: Good Product Design


1
Chapter 6
Asset-Liability Management for Actuaries
  • Meeting the Clients Needs Good Product Design

Shane Whelan, L527
2
The Heart of the Matter
  • Good (financial) product design resolves the
    tension between developing a product that meets
    the needs of (targeted) customers and meeting the
    providers need for profit (return on capital)
    with acceptable risk.
  • Aside from capital, the provider brings other
    less tangible but important assets to the table
  • Knowledge and expertise that reduces risk
  • Competitors products new or increased demand
    from underlying demographic or sociological
    shifts using technology to reduce costs
    changing regulations/taxation/social welfare
  • In-place systems that reduce marginal cost
  • Salesforce, other sales channels, head office and
    its systems
  • Its in-force business that can help diversify
    risk of new product.

3
Product Design Cycle
Identify a need/market
Design a Product
Review Product Design
4
Characteristics of Good Design
  • Meet, and demonstrably meet, customers needs
  • So meet effective demand
  • Level of benefit and contingencies on which paid.
  • Flexible to change as customers needs change?
  • Be profitable
  • Acceptable levels of profitability will depend on
    capital requirements, which, in turn, depend on
    the riskiness of the benefits promised.
  • Is it best use of scarce capital?
  • Options guarantees are especially
    capital-intensiveare they sufficiently
    appreciated by customer?
  • Whenever there is a period of time between
    contract effected and the benefits actually being
    provided, there is a decision as to how and when
    monies should be set aside to pay for the
    benefits. Matching assets? Invested in what
    assets? This can be key.
  • Simple to understand
  • Kitemarking
  • Everything should be made as simple as possible,
    but not simpler. Einstein
  • Is With-Profits a product that is oversimplified?
  • Cross-subsidies can helpbut beware of dangers!

5
Characteristics of Good Design (Cont.)
  • Be transparent in its structure and charges
  • This is often in conflict with other
    characteristics, especially to sell product in
    volumes. The resolution of the conflict depends
    on the time-scale you are thinking inbut
    short-termism now seems to dominate.
  • The charges levied will need to meet the costs
    incurred by the provider in setting up and
    managing the financial structures.
  • Product design, advertising, administration
    set-up
  • Commission, other sales costs, cost of collecting
    contributions, cost of paying benefits,
    overheads, profits, management of assets.
  • Have a large enough market
  • Remember, we want to maximise total profit
    profit per unit X number of units.
  • Provide fair terms on premature terminationsee
    next few slides.
  • Fair to policyholder, to other policyholders and
    to provider.
  • Be aware of self-selection or selection-against-th
    e-office. This might inform benefits on premature
    termination making policy paid-up rather than
    giving a surrender value or never granting
    surrender terms.
  • Also market practice, regulatory requirements,
    and how to set fair terms.

6
Benefit Schemes Early Leavers
  • For a benefit scheme the actual benefits on
    discontinuance are likely to be well-defined, but
    if they are to be transferred away to another
    provider a value will need to be placed on them.
  • Such a value will need to be equitable between
    members who leave and members who remain.
  • What happens if assets are insufficient to
    provide the full value of the accrued benefits
    for all members?
  • Reduce lump sum payment to leaving member to
    reflect the lower level of funding.
  • But give the member the option not to transfer
    benefits away, or, at any event, disclose the
    reduction factor applied.
  • Check regulations!
  • What happens if assets more than sufficient?

7
Insurance Contracts Early termination
  • Should company take full profit from sold
    contract or accept reduced share as contract
    clearly not ideal for surrendering policyholder?
  • Key concept is asset share accumulated premiums
    less actual expenses and cost of cover, at actual
    earned net rate of return.
  • Asset share sets maximum that company can pay out
    in the long run.
  • Policyholder will generally just look at premiums
    paid in early years or, at later years, the
    maturity benefits.
  • To be fair or to be seen to be fair?
  • What company said in illustrations

8
Product Design Issues
  • Product definition
  • Event(s) giving rise to valid claim
  • Exclusions
  • Underwriting
  • Rating factors in setting standard premiums
    (e.g., age, sex, smoking or age, sex, engine cc)
  • Need to know target market to set standard rates
    and rating factors
  • Pricing
  • Here we mean pricing strategy cost-based
    pricing, marginal costs only, market or
    competition-based pricing
  • Determine price relatives between different
    marketing channels.
  • Customer Service
  • Level of support/administration and its cost.
  • New system or altering existing one?

9
Product Design Issues (cont)
  • Marketing Distribution
  • Many channels differentially priced?
  • Staff training
  • Capital requirements
  • New business strain timing of capital needs
    risks.
  • Monitoring the emerging experience
  • For operational, financial and risk management.
  • Also statutory reports
  • Sub-divided by sales channel or other
    classification.
  • Meeting legislative and regulatory requirements
  • Valuations, etc.
  • Reinsurance

10
Risk Process Planning (RPP)
  • Any project has risks. Risk Process Planning is
    a method of assessing and controlling risk
    specifically in financial product development.
  • RPP made up of the following parts
  • Risk event definition
  • Define the risk events e.g., failure of product
    to sell, high lapse rate, etc.
  • Timing
  • When will risk event be known to have happened
  • Risk scoring or evaluation
  • Probability of event sometimes scored
  • Scoring of severity is often on scale 1 to 5 with
    1minor loss 5unbearable loss
  • Also consider correlation with other risk
    underwritten

11
Risk Process Planning (RPP)
  • Cont. RPP made up of the following parts
  • Management
  • Control that can be exercised on risk event
    again sometimes simply scored.
  • Actions to prevent or limit damage of risk event.
  • Parties involved
  • Team of experts on different aspects
  • Can see the big picture
  • A risk-scoring team will often be a subcommittee
  • Facilitator
  • A general expert in applying RPP

12
Risks of a Motor Insurance Book
  • A small general insurance company writes only
    individual motor insurance business.
  • Discuss the areas of risk and uncertainty
    inherent in the claims experience of this insurer
    and how they might be reduced.

13
Solution might include
  • Risk in the claims experience
  • Outcome of business on books and future business
  • Claims frequency and amount variable so
    especially so for small insurer due to random
    incidence and amounts.
  • With delay in recognition due to late
    notification/time to eventual settlement
  • High variably might disguise underlying trends
  • Risk characteristics of policyholders may change
    in time
  • Underpricing when introducing new policy options
  • Crime or fraud increasing with time
  • General claims inflation higher than expected
  • Taxation of cars or repairs or other changes to
    legislation
  • Court award inflationnew precedents on allowable
    claims or quantification of damages
  • Unintended consequences of policy wordingdirect
    or with reinsurer

14
Solution might include
  • A catastrophe event
  • Due to geographical concentration flooding,
    hailstones, hurricane leading to multiple claims
    in portfolio.
  • One huge claim
  • Competition and the insurance cycle.
  • So how are the identified risks reduced?

15
Product Development Process
16
Example
  • A life company is considering launching an
    immediate annuity, the amount of each future
    payment dependent on the level of the equity
    market at the time, subject to a guarantee that
    the payment in any year will not be less than 95
    the payment of the previous year.
  • Discuss the product design, and indicate if you
    are satisfied that this product should be
    launched.

17
Completes Chapter 6
Asset-Liability Management for Actuaries
  • Meeting the Clients Needs Good Product Design

Shane Whelan, L527
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