Life insurance and similar contracts
Domain 5 covers life assurance, annuities and similar contracts: product design, pricing, reserving, asset-liability management and profit recognition.
Core ideas
- Products: term, whole life, endowment, annuities, with-profit, unit-linked and universal life. Each allocates investment, longevity, mortality and expense risk differently between policyholder and insurer.
- Bases: gross premium valuations compare the present value of benefits and expenses with future premiums; net premium valuations take credit only for a net premium derived from the valuation basis. Purpose drives the basis - Solvency II uses best-estimate liabilities plus a risk margin.
- Options and guarantees (GARs, GAOs, unit-linked guarantees) cost money and must be priced and hedged.
- With-profit business needs asset shares, smoothing, terminal bonuses and an estate to support bonus expectations.
Worked example
A with-profit policy has an opening asset share of £12,000. It pays a premium of £2,000, incurs expenses of £400 and claim outgo of £900, and earns 5% on the fund. Closing asset share = (12,000 + 2,000 − 400 − 900) × 1.05 = £13,335. Reasoning: the asset share is a retrospective accumulation of actual experience per policy, used to set fair bonuses; it is not a reserve and is not guaranteed. Smoothed payouts above asset share draw on the estate.
Traps
Confusing asset share with mathematical reserve; assuming declared bonuses are guaranteed; ignoring lapses and paid-up policies; treating unit-linked guarantees as costless; forgetting margins for mortality, expenses and persistency.