IFoA SP2 key terms

The central, unbiased assumption about a future experience factor such as mortality, persistency or expenses, with no deliberate margin for prudence. It is the starting point from which margins and risk adjustments are added when setting reserves or pricing.

A deliberate addition to or subtraction from a best estimate assumption so that the resulting figure is more likely to prove adequate than inadequate. The size depends on the uncertainty of the assumption and on regulatory or capital requirements.

The amount included in a liability or valuation to reflect the compensation an insurer would require for bearing uncertainty in future cash flows. Under Solvency II it is added to the best estimate liability to form technical provisions.

The total liability an insurer holds for its insurance obligations, normally equal to the best estimate liability plus a risk margin. It must cover obligations to policyholders over their full remaining lifetime, not just the next year.

In Solvency II, the additional amount above the best estimate liability that ensures the technical provisions equal what another insurer would need to take over the obligations. It is calculated using a cost-of-capital approach applied to future solvency capital requirements.

The rate of return investors require on the capital they supply to support insurance business. It is used both to discount future profits when appraising products and to compute the risk margin on a portfolio of liabilities.

The total amount the policyholder pays for cover, comprising the expected cost of benefits, expenses, and a loading for profit and risk. It must be sufficient to fund claims, commissions, administration and the required return to shareholders.

The portion of the gross premium needed to fund expected benefits only, ignoring expenses and profit. Comparing the net premium with actual premiums is a simple way to see how much loading is available for costs and margins.

A policy liability calculated prospectively as the present value of future benefits and expenses less the present value of future gross premiums. It is generally lower than a net premium reserve because expense loadings in the premium are recognised.

A prospective reserve equal to the present value of future benefits less the present value of future net premiums, using valuation assumptions set by the actuary or regulator. It is a common statutory minimum basis in many life insurance regimes.

A modification to a net premium reserve that allows initial acquisition expenses to be recognised, producing a reserve lower than the unmodified net premium reserve but never below zero. It prevents new business from being over-reserved and creating a surplus strain.

The reduction in an insurer's surplus that occurs when writing new policies, because acquisition costs and reserves are set up before premiums have been received. It is a key reason fast-growing insurers need extra capital.

A technique that projects the cash flows of a policy or portfolio year by year, allowing for premiums, claims, expenses, reserves and investment return, then discounts the resulting profits. It produces measures such as the internal rate of return and net present value.

The discount rate at which the present value of a product's projected profits equals zero. In profit testing it is compared with the insurer's required return or hurdle rate to judge whether the product is worth writing.

The policy year in which the cumulative discounted profit from a product first becomes non-negative. It shows how long capital is tied up before the product repays its acquisition costs.

The expected rate of death at each age or duration used in pricing and valuation. It is normally derived from a published mortality table adjusted for the insurer's own experience, target market and any underwriting selection.

The pattern where mortality is lower in the first few years after underwriting because recently accepted lives have been screened for health. It gradually converges to ultimate mortality as the effect of selection wears off.

The expected proportion of policies that remain in force each year, used to project premiums and claims. It directly affects profitability, since lapses remove future premium income while acquisition costs have already been incurred.

The termination of a policy because the policyholder stops paying premiums, whether by choice or through inability to pay. Lapse rates are a major assumption in pricing and can cause losses if early lapses are higher than expected.

The amount paid to a policyholder who terminates a policy with a cash value before maturity or death. It is usually less than the reserve held, with the difference helping the insurer recover unrecouped acquisition expenses.

A policy on which the policyholder stops paying premiums but keeps a reduced level of cover, with no further premiums due. It is an alternative to surrender that preserves some protection and avoids a full termination.

The expected rate of sickness or disability inception and the expected duration of claims, used for critical illness, income protection and long-term care products. It is typically derived from insurer experience and industry tables.

The rate at which new claims arise in a given period, usually expressed per thousand lives exposed. For morbidity business it drives the expected cost of new sickness or disability claims.

The rate at which existing sickness or disability claims end, through recovery, death or expiry of benefit. It determines the average duration of a claim and therefore the size of the claim reserve.

The liability held for claims that have been incurred but not yet settled, including reported claims and those not yet reported. It is estimated from expected settlement amounts, delays and the possibility of reopening.

Claims that have occurred before the valuation date but have not yet been notified to the insurer. An estimate for them must be included in reserves, often using development patterns from past experience.

The process of assessing and classifying the risk a proposed policyholder presents, then deciding whether to accept, decline, or accept on special terms. It protects the insurer against anti-selection and supports the mortality assumptions used.

The tendency for people who know they are higher risk to buy or retain insurance more readily than lower-risk people. It can worsen experience relative to assumptions and is countered by underwriting, exclusions and waiting periods.

A policy that shares in the insurer's surplus through regular and final bonuses, in addition to a guaranteed basic benefit. Bonus decisions are discretionary but must be made fairly between generations of policyholders.

The accumulated value of the premiums paid on a with-profits policy, less charges and claims, rolled up with investment return. It is a key reference point for deciding how much bonus to declare.

The practice of holding back some investment gains in good years to support bonuses in poor years, so that payouts to with-profits policyholders vary less than underlying asset values. It aims to be fair over time across policyholders.

A unit-linked style contract in which premiums are credited to an account that earns interest and is charged for mortality and expenses. The policyholder can often vary premiums and the level of cover within limits.

A policy where the benefits are linked to the value of units in an investment fund chosen by the policyholder. The insurer bears only expense and persistency risk on the unit fund, while the policyholder bears investment risk.

The liability for the unit fund element of a unit-linked policy, equal to the value of units allocated to the policyholder at the valuation date. It is straightforward to calculate because it follows the market value of the units.

The liability held for the non-unit element of a unit-linked policy, covering expected future expenses and any guaranteed minimum benefits not met by the unit fund. It is projected using cash flow techniques and must not be negative.

A stress test in which the insurer's assets are assumed to fall sharply in value, to check that reserves and solvency remain adequate. It reveals how exposed the balance sheet is to a fall in equity or property markets.

Insurance contracts where policyholders are entitled to a share of the insurer's surplus, commonly through bonuses. It creates discretion for the insurer but also obligations of fair treatment between policyholder groups.