Marketing

Pricing

Valuation and Financial Statements

Product Development

Marketing

• special position of public trust - financial well-being & business conduct of insurers is of such importance to so many people
• PO can lose $ if insurers don't adhere to standards
• policies are complex documetns not easily understoon
• PO wants to be treated fairly and ethiclly w/ accurate info

• Background
  • McCarran-Ferguson Act (1945) - state regulates insurance
  • insurance dept - admin agency w/in each state
  • insurance commissioner - head of ins dept
  • NAIC - Promostes coinsistency w/in each state's ins dept
  • insurance laws in two basic categories
    • solvency laws - esnure insurers financially able to meet obligations
    • Mkt Conduct Laws - ensure insurers and distributors operate fairly adn ethically
• Regulation of Products
  • protect customers by requiring certain provisions or not allowing certain provisions
  • require simplified language
• Regulation of pricing
  • reasonbale rate - cover's insurers expenses & provides a fair profit
  • competition usually keeps rates reasonable
  • loss ratios - total claims incurred / total prems rec'd
  • adequate rate - high enough to provide insurer w/ enough $ to pay operating expenses and benefits when they come due
    • life ins rate adequacy indirecly regulated via min reserve reqs
  • equitable rate - prem rate that varies from policy to policy based only on factors affecting the product's costs - not allowed to vary based on race or religion etc
• Regulation of Distribution
  • Licensig of Ins Producters - to get license, must prove: are of good character/meet residency req/pass an exam
    • license for each state/line they sell
    • reciprocity - two states agree that if ok in one state, ok in the other
  • Prohibited Sales Practices
    • Misrepresentation - false or misleading statements
    • Replacement - replacing one contract with another. In itself, not illegal
      • Twisting - misrepresent features of a product to induce replacement
      • Churning - replacing one policy after another to earn series of 1st year commissions
    • Rebating - offer inducement to purchase (not banned in all states)
    • Missappropriation - illegal use of PO funds
    • Commingling of Funds - combining monies belonging to PO(s) w/ producer's own funds
  • Suitability requirement - need reasonable grounds for recommending a specific product as suitable for customer's needs
• Regulation of Promotion
  • Advertising and sales Promotion Materials
    • Advertisement - any material designed to create public interest in life ins/annuities, insurer, producer OR induce public to purchase, increase, modify, restate, borrow on , surrender, replace, retain a policy
    • Insurer ultimately responsible, even if producer creates ad
  • Disclosure
    • NAIC Disclosure Model Reg
      • aid customers in puchasing suitable & reasonably priced ins
      • provide accurate adn reliaebl info to ensure competitive mkt
      • discourage undesirable mkt behavior
    • must give prospect a Buyer's Guide and Policy Summary
    • Buyer's Guide
      • describes various types of ins and points out +/- of each type
      • explains cost comparison indexes
    • Policy Summary
      • disclosure info on specific policy being considered by prospect
• Market Conduct Examinations
  • peridodic exams of insurance co to ensure they comply w/ state laws
  • areas of focus in mkt conduct exam
    • cert of authority adn licensing of agents/brokers nonf options on life ins pols
    • policy form/endorsment approvals sales/advertising materials
    • u/w and rating of policies apps rejected/declined
    • pols cancelled/not renewed replacements
    • claims practices customer complaints

• Antitrust Regulation
  • state antitrust regs, but subject to certain provisions of Fed antitrust laws
  • Boycott - competing cos agree to refrain from doing business w/ another co
  • Coersion and Intimidation - methods of force used by a business to make another business act or refrain from acting in a certain manner
  • Price fixing - competing businesses act together to affect the price of a product
• Consumer Protection Regulation - affect mktg of life and health ins
  • FTC Act - regulates unfair competition, deceptive business practices adn prohibits false or deceptive advertising that crosses state lines
  • Fair Credit Reporting Act (FCRA) - must comply when insurer obtains credit reports for u/w or claims investigation
  • GLB Act Privacy Provision - protect non-public personal info from indescriminate dessemination.
    • disclosure of practices @ beg of relationship and annually thereafter
    • allow opt-out of sharing
    • maintain policies to protect security and confidentiality of non-public info
    • refrain from sharing acct #s w/ non-afiiliated 3rd parties for mktg purposes
  • HIPAA 1996 - privacy protections for group adn health mkt
  • Regulation of Variable Ins Products
    • subject to regulation by SEC
    • 4 fed Laws affect mktg of variable products
      • Securities Act of 1933
      • Securities Exchange Act of 1934
      • Investment Co Act of 1940
      • Investment Advisors Act of 1940
    • Securities Act of 1933 - Truth in Securities Act
      • general fraud provision - prohibits misrep
      • registration provision - must provide essential info
      • prospectus - most of the info in the registration statement
        • any communication (written or oral) that offers security for sale
    • Securities Exchange Act of 1934 - gave SEC broad authority to regulate securities
      • primary focus - registration of brokers and dealers who sell securities
      • securities broker - indiv, corp or other legal entity engaged in business of buying/selling securities for the account of others
      • securities dealer - engaged in business of buying/selling securities for own account
      • firms that sell must a) register as B-D w/ SEC and b) become member of NASD
      • NASD - non-profit self regulating org responsible for making sure everyone follows rules
      • SEC registration of B-D - most often an insurer will create and register a subsidiary ot be a registered B-D
      • NASD Registration of Respresntatives and Principals
        • Registered Rep
          • business assoc of NASD member
          • engages in securities business on behalf of member
          • passed a specified NASD exam
        • Principal
          • officer/manager or an NASD member
          • involved in day-to-day operations of securities business
          • qualified as a registered rep
          • passed additional exams
      • NASD regulatory Oversight Activities
        • B-D must supervise reg reps & principals to ensure compliance
        • reg reps and principals must serve customers properly and deal fairly w/ public
        • reg reps mush have reasonable grounds for believing recommendation is suitable
        • NASD approval of ads and sales lit
          • Name of B-D
          • no promises of results exaggerations or opinions w/ no reasonable basis
          • don't imply state or fed endorsement/approval of product
          • no rediction/project o finvestmetn results
      • SEC "Good" Internal Controls
        • strong/capable compliance/legal staff
        • create regular exceptino reports and review
        • regular communication w/ customer - disclose fees/risks
        • periodic reviews of customer holding by branch office
        • written procedures fro branch audits w/ written reports as results
        • clear compliance guidance to producers
        • regular provider trainig - compliance/security laws/self reg rules
        • immediate discipline
        • review producers to ensure continued licensing/education req
        • optical scanning instead of manual paper-based processing
        • written procedure to minimize error/delays
        • quality control unit to monitor trx processing
        • procedures to separate adn secure incoming premium payments
    • Investment Company Act of 1940 - regulates conduct of investment cos
      • Sep Acct considered an investment company by act
    • Investment Advisors Act of 1940 - conduct of investment advisors
      • investment advisors - compensated for providing advince to investors about value of securities or advisability of buying/selling securities
      • if producer sells VA/VUL and only gets commissions, not req'd to register as investment advisor, jsut reg rep or principal
  • Federal Regulation of Bank Insurance
    • Licensing and Locatoin
      • agency/B-D must be clearly identified adn separate from teller area
      • employee must be properly licensed/registered
      • must fully and accurately disclose identity of business providing the service
    • Prohibited Sales Practices
      • Tying Arrangement - conditions the sale of one item on the sale of another
    • Advertising adn Dsiclosure Requirements
      • Fed Banking laws require additional disclosures
        • product is insurance/annuity and not bank-guar product
        • amounts payable are premiums and not deposits
        • product is not insured by FDIC or other gov't agency or bank

• Background
  • Dual regulation - both federal and provincial govt regulate
  • Federal - OSFI
• Provincial Regulation of Market Conduct
  • Insurance Act of each procince regulates conduct and creates Office of Superintendent of Ins
  • Canadian Council of Ins Regulators (CCIR) - similar to NAIC
    • because of CCIR - fairly uniform regs across provinces
  • CLHIA (Canadian Life and Health Ins Association)
    • voluntary associate that promotes self-regulation to avoid over-regulation
    • CLHIA guidelines
  • Products
    • CCIR Uniform Life Ins Act & Uniform Acc and Sickness Ins Act - adopted by all provinces by Quebec
    • CLHIA Indiv Var ins Contracts (IVIC) Guidelines
      • Compliance Report - questions exploring compliance
      • Information Folder - collection of 21 items to prove financial soundess of a product
    • Policy Form filing required if
      • condition to obtaining license to conduct business w/in province
      • before mktg an individual variable life contract
      • no new filings for trad products after licensed
  • Pricing
    • indirectly since ins must charge adequate rates to fund sufficient assets
    • prohibit unfair discrimination (race/sex/religion/etc)
    • can't discriminate between two people who present same risk
  • Distribution
    • Producer Licensing - no special license to sell variable products but must be accredited by provincial securities commission
    • Prohibited Sales Practices - similar to US
      • in addition, license revoked if
        • violates ins act and/or related regs
        • material misrep on license app
        • guilty of fraudulent practice
        • demonstrates incompetence or untrustworthiness in trx of life ins
  • Promotion - prohibits specified ad/sales promotion practices adn mandates cost/benefit disclosures
    • Advertising and Sales Promotion - prohibits
      • false/misleading ads or statement re: policy features
      • conduct that results in unreasonable delay/resistance to fair settlement of claims
    • Add'l guidance by CLHIA prohibits
      • false/misleading statement/presentations/testimonials
      • disparaging statements about other insurers or their products
      • statements w/ tech/industry language beyond general public understanding
      • guarantees unless conditions/limitations fully explained
      • Coupon Advertisements
        • must be truthful and not misleading
        • must define terms & disclose exceptions/exclusions/limitations
  • Cost adn Benfit Disclosure
    • CLHIA-developed buyer's guide
    • policy summary
    • if guarnateed values of reatures mentions, must be display inillustrations
    • if non-guar elements displayed, illustration must have at least two summaries
    • variable products - must give copy of Info folder onfile w/ office of super
      • describes guar/non-guar benefits
        • method of determing benefits
        • surr/loan/nonf provisions
        • charges imposed if surrendered
• Federal Regulation to Maintain Competition
  • Ins Co Act - Admin by OSFI - regulates
    • fed incorp ins cos
    • insurers incorp outside of Canada but do business in Canada
    • provincially incorp insurers that choose to register w/ fed gov't
    • regulates incorporation, corp governance, solvency
  • Competition Act (1986)
    • Prohibits
      • mergers/monopolies that may operate to detriment of public interest
      • price fixing agreements that unduly lessen competition
      • other anti-competitive or deceptive mktg or unfair trade practices
• Feds - Privacy
• Provinces - Customer Protection

• Planning
  • - Set Marketing objectives
  • - establish guidelines for implementation and control of mktg activities
• Organizing
  • - establish a framework for carrying out mktg plans
• Implementation
  • - Execute mktg plans
• Control
  • - analyze results
  • - evaluate performance
  • - make necessary changes

• +Corporate Planning
  • primarily strategic
  • consists of establishing company's overall business plan
  • top-down. begins by deining the company's mission - defines scope of org's business activities and business direction
  • Establishs Corp objectives - long term results co hopes to achieve
  • Outlines Coprorate Strategies - long term methods used to achieve objectives
  • must regularly evaluate plans to make sure still appropriate
• +Marketing Planning
  • bottom up portion of planning process

• 1-5 years into the future. review and update as necessary. as oftern as every 6 months. focus on long term
• - establishes marketplace objectives
• - defines the target market
• - develops mktplace stategies
• - defines resource needs

• 1-2 years into the future - focus on the day-to-day
• - develops action-oreineted product, price, distribution and promotion tactics
• - describes when activities will take place, how they will be performed and who will perform them

• 3 primary activities: analyze situation, establish objectives, develop course of action
• Conducting a Situation Analysis
  • 3 primary parts: environmental analysis, environmental forcast, internal assessment
  • Environmental Analysis - ongoing exam of outside events/relationships that can influence strategic decion making
    • Key environmental areas for Financial Services Corp (fig 5-3 p 105)
      • - current target markets
      • - competition
      • - economy
      • - society
      • - technology
      • - regulation
      • - labor
      • - distributors
      • - international conditions
  • Environmental Forcast - prediction of major environmental trends that will affect a companies business activities
    • several types of forcasts available from businesses, universities, governments and industry associations
    • commercial forcasts are a good starting point
  • Internal Assessment - exam of co's current activities, strenghts, weekenesses and ability to respond to potential threats & opportunities in environment
    • internal factors that have greatest effect on co's mktg planning:
      • - mission
      • - fin, tech, human resources
      • - current distribution systems
      • - product lines
      • - operational efficiency
• Tools of Analysis
  • SWOT Analysis
    • Strengths, Weaknesses, Opportunities and Threats
    • Mktg Opportunity arises when right combo of circumstances allows co to use its strenghts to take advantage
    • Strategic Window - time period where optimum fit between co's distinct capabilities and key requirements of mktg opportunity
  • Business Portfolio Analysis
    • allows co to evaluate business units according ot their potential contribution to co
    • determines units potential for:
      • - generating financial resources
      • - requiring financial resources
    • SBU - strategic business unit
      • - operated as a separate profit center
      • - own seperate set/share of customers adn competitors
      • - own mgmt (generally)
      • - owm mktg strategy
    • Marketshare/Mkt Growth matrix - Boston Consulting Group
      • - Star - high mkt share, high growth mkt - becomes a cash cow when mkt growth slows
      • - Cash Cow - high mkt share, low growth mkt
        • primary role - provide income to cover corp overhead, pay divs, finance R&D
      • - Question Mark (aka Problem Child) - low mkt share, hight growth mkt
        • requires more cash than they generate
      • - Dog - low mkt share, low growth mkt
        • generate enough revenue to cover their own expenses
        • unlikely to become stars or cash cows
      • many SBUs have the following life cycle
        • Question Mark -> Star -> Cash Cow -> Dog -> sold/discontinued
    • Market Attractiveness/Business Strength Matrix - GE and McKinsey & Co
      • created to address problems w/ mktshare/mkt growth matrix
      • 9 matrix cells
      • business strength - strong/average/weak (x-axis)
      • mkt attractiveness - high/medium/low (y-axis)
      • "A" - good investment/growth opportunity
      • "B" - average opportunities
      • "C" - little growth/investment potential
        • high A A B
          • med A B C
          • low B C C
            • strg avg weak
      • mkt attractivness - composite index - uncontrollable env factors
        • - market size - market growth rate
        • - gov't regulation - mkt stability
        • - competitive intensity - tech reqmnts
      • business strength - composite index - controllable factors
        • - price competitivness - product quality
        • - customer loyalty - mktg skills
        • - sales growth rate - relative cost advantages
        • - tech and fin resources

• objectives s/b
  • - clearly stated
  • - specific and measurable
  • - realistic
  • - actionable
• objective shoudl specify (in quantifiable terms) what is to be accomplished and time period to accomplish it
• Corp Objectives - normally 1-5 years
• Marketing Objectives
  • primary - describe overall mkt response they hope to achieve in target mkt
  • secondary - cover mktg functionnnnnnns needed to carry out plan

• Corporate Strategies
  • - intensive growth strategy - usually requires significant financial resource
    • + Market Penetration - increasing sales of current products to current mkts
    • + Mkt Development - increasing sales of current products to new mkts
    • + Product Development - increasing sales of new/modified products to current mkts
  • - diversified growth strategy - venture beyond normal business domains
    • + Horizontal Diversification - intro diff products to co's current mkt
    • + Concentric Diversification - new mkts, new products similar to current products or current mktg methods
    • + Conglomerate Diversification - new mkts, new products that bear no relationship to curernt products
      • same product related new product unrelated new product
    • new mkt mkt development concentric diversification conglomerate diversification
    • same mkt mkt penetration product development horizontal diversification
  • - Integrated Growth Strategy - taking over another level of industry or dist channel
    • + Forward Integration - control of distribution channel
    • + Backward Integration - upstream (manufacturer or supplier)
    • + Horizontal - competitor
• Marketing Strategies
  • focus w/r to SBU's mkt share
  • + Build Strategy - increase mkt share. usually S/T loss (capital outlay) for L/T gain
    • most appropriate w/ relatively low mktshare in relatively high growth rate mkts
    • Question Marks or "A"s
  • + Hold Strategy - maintain mkt share
    • Cash Cows or "B"s
    • appropriate for high mkt shares in low growth mkts
  • + Harvest Strategy - maximize S/T earnings and cash flow
    • appropriate for weak growth potential
    • weak Cash Cows, Qeustion Marks, Dogs adn "C"s
  • + Withdrawal Strategy - selling/discontinuing a SBU
    • appropriate for weakest growth and inv potential
• Tactical/Action Programs
  • - what activites are to be performed
  • - how/when/where they are to be performed
  • - who is responsible for performing each activity
  • - how much each activity will cost
  • - type and magnitude of results expected from each activity
  • - main elements of uncertainty involved
  • - how results will be monitored and evaluated
  • Benchmarking - identify best practices adn outcomes
    • - emulate best practices to equal/surpass best outcomes
    • avoids reinventing the wheel
  • programs must be coordinated and integrated to be successful
  • formed for each marketing area and combined to form annual mktg plan
• Setting Budgets
  • tell Sr Mgmt how much and when - bottom up
  • sometimes top down and funds need to be allocated. Proposed programs scaled up/down as necessary
  • budgets provide feasibility info

• written document that specifies marketing goals for a product/product line and describes strategies and implementation and control efforts co intend to use to achieve those goals
• focuses on target markets and elements of marketing mix
• Benefits
  • - facilitates communications among all levels of org and among function units
  • - allows mgmt to monitor consistency of actions across units
  • - focuses EE on right issues
  • - keeps poeple focused on overall goals
  • - provides basis of performance comparison
• Elements
  • - executive summary
  • - situation analysis
  • - mktg objectives
  • - mktg strategies
  • - tactical/action programs
  • - budgets
  • - control mechanisms

• Essential Mktg Functions
  • - Information Management
  • - Marketing research
  • - product development and pricing
  • - sales and distribution
  • - advertising, sales promotion and publicity (aka Mktg Communications)
  • - customer relations
  • - mktg personnel development
  • - mktg mgmt and admin
• Four common mktg structures: function/product/geog region/customer type
• Organization by Function
  • most common
  • different areas of responsibility depending on work performed
  • ex. Chief Mktg Officer/Mkt Research Mgr/Sales Mgr/etc
  • Advantages
    • - simplicity
    • - focuses on developemnt of managerial and tech skills
  • works best w/ small cos or cos w/ homogenous customers
• Organization by Product
  • each SBU responsible for its mktg (most of)
  • may be some shared services
• Organization by Geographic Region
  • usually mktg manager for each region
  • usually some shared services
• Organization by Customer Type
  • mktg manager for each division
  • ex: households/small business/big business
• Combination Structures
  • flexible - meets both co's strategic implementation needs and customer needs
  • Matrix Organizational Structure
    • project manager directs individuals from different function areas
    • two bosses during project

• Mktg Implementation - process of translating mktg plans and strategies into action
• accomplished through day-to-day tactical and operational activities

• marketing control - process of examing results of mktg plans and company to plan and taking actoin to keep it on track

• performance std - internal vs external std
  • - usually incorporated into mktg plan
• management by exception - mgmt only gets involved if performance outside acceptable range
  • - saves time and allows attention to be focused on problems/opportunities
• if a problem, read to identify toe cause and take actions to correct
  • - change tactical/action programs
  • - establish new implementation method
  • - new strategies
  • - modify how performance data collected/analyzed
  • - re-evaluate performance standards
• control tools
  • sales analysis vs
    • - forcasted sales - prior years sales
    • - expenses to generate sales - competitors' sales
    • - estimated mkt potential - current industry sales
  • measured - # products, 1st yr comm, face ,avg prem, etc
  • expense analysis
    • natuaral accounts - ledger accounts
    • functional accounts - based on purpose
    • expense ratios - ex. mktg expenses/$1m face sold
  • profitability analysis
    • compares sales to expense incurred to generate sales
    • use several years data since for line ins, 1st yr expenses > 1st yr revenues
    • valuable source of info since combines sales and expense info
  • mktg audit
    • systematic examination and appraisal of mktg environment, objectives, startegies, tactical/action prgms, organiztional structure and personnel
    • key areas of mktg audit (chart p 135)
      • mktg environment
        • macro environment
        • task environment
          • mkts adn customers
          • other factors in mktg system
      • mktg strategy
        • business mission and mktg objectives
        • mktg strategy
        • budgets
      • mktg organization
        • formal structure
        • functional efficiency
        • cross-functional efficiency
      • mktg systems audit
        • mktg info system
        • mktg planning system
        • mktg control system
        • new product developemnt
      • mktg productivity audit
        • profitability analysis
        • cost-effeciveness analysis
      • mktg function audit
        • products
        • price
        • distribution
        • promotion
  • Reporting Sytems
    • - provide managers w/ detailed summary info as needed
    • - provide accurate adn timely info
    • - be flexible to adjust to co's changing info needs
    • - be cost effective
    • - easily understood by
      • + those who evaluate performance
      • + those whose performance is being measured
    • detail s/b appropriate for level
      • lower level needs more detail
      • higher level mgmt needs just summary

• dividing large markets into smaller markets w/ similar product/mktg mix needs
• single variable segmentation - only 1 variable to segment market
• multiVariable segmentation - uses combo of variables
• Requirements for Effective Segmentation
  • - customers should have similar product needs/buying habits
  • - needs/behaviours s/b distinguishable from other segments
  • - potential sales/costs/profits s/b lare enough to be measured and compared to other segments
  • - profit potential enough to warrant segment attention
  • - customers accessible thorugh currently available means
  • - size/composition s/b relatively stable over planning period
• Bases for Segmenting Consumer Markets
  • Geographic Segmentation
    • country/region/state/county/zip/legal boundaries/rural-suburuban/urban
  • Demographic Segmentation
    • age/sex.marital.household composition/income/education/occupation/family life cycle/nationality/race/etchic group/social class
  • GeoDemographic Segmentation - combo of geographic adn demographic
    • economic means/cultural background/perspective/neighborhood
  • Psychographic Segmentation
    • lifestyle/activities/interests/opinions
  • Behavioristic Segmentation
    • benefits sought/usage rate/buyer readiness/pref method of purchase/risk tolerance/buyer loyalty
  • Demographic - commoonly used in consumer markets
    • traditional life ins demographics - hi/middle/low-income households and families/boomers/seniors
• Bases for Segmenting Organizational Markets
  • Organizational Mkts - group benefits and continuation of business operations
    • therefore two markets, group and business
  • Georgraphic Segmentation - simialr to consumar markets
  • Demographic Charachteristics
    • business activity/type of group-organizatoin/size of group-organization
    • SIC - Std Industrial Classification - 1930
    • NAICS - N. American Industry Classificatino System - by-product of NAFTA
    • small groups <=100 - 80% of contracts, 25% or prem
    • medium groups 101-499 - 10% of contracts, 25% of premiums
    • large groups 500+ - 10% of contract, 50% of prem
  • Behavioristic Segmentation
    • similar to consumer markets - usage is a key

• process to identify, select and focus mktg efforts
• Evaluating Potential Target Markets
  • Mkt Size and Growth Potential
    • majority fallacy - blind pursuit of largest, most easily identified or most accessible mkt segment
    • competition makes big mkts less profitable
    • should offer combo size/growth/profitability that best meets co's needs
  • Mkt Attractiveness
    • depends on level of compettition and buying power of consumers
  • Company Goals and Resources
    • only puruse targets if it has (can easily get) fin/tech/hr necessary to compete sucessfully
• Target Mktg Strategies
  • Undifferentiate Mktg - mass mktg - singel mktg mix for entire mkt
    • + cheaper since only one mkt strategy
    • - might miss differences w/in segment
    • - disadvantage to specialty marketers
  • Concentrated Mktg
    • for a product - focus all mktg efforts on a single segment of total mkt
    • Niche Mktg - form of concentrated mktg w/ narrowly defined mkt
    • - all eggs in one basket
    • + can be profitable
  • Differntiated Mktg
    • offer differing product/mktg mixes to appeal to diff segments
    • - most expensive
    • + better served customers = incr customer satisfaction = incr sales
  • Factors to consider when picking mktg strategy
    • company resources - if limited, concentrated probably best strategy
    • product variability - homogenous products - undifferentiated mktg
    • Mkt Variability - if buyers have similar usage/purchase patterns - undifferentiated
    • product's life cycle stage - new products - concentrated/undiffernetiated
      • - mature -differentiated
• Consumer and Organizational Target Markets for Ins Products
  • Affluent Consumers
    • mass affluent - 100k -$1mil liquid assets - 99.9% of affluent mkt, 54% of total mkt assets
    • high-net-worth - $1-25 mil liquid assets - 0.1% of mkt, 31.3% of assets
    • ultra-high-net-worth - 0.001%, 15.1% of total mkt assets
  • Single-Parent Families - need large amt ins to protect single wage earner
  • Non-family Households - low need for life ins, high need for health/retirement products
  • Working Women - strong potential for wide range of products
  • Employer Groups - ex. negotiate trusteeship/voluntary trade assoc/MEWA
  • Small Businesses - rapidly growing segment - approx 99% of businesses are small businesses
    • significant market for products that
      • - protect against loss due to death/dis of owner
      • - preserve value/prevent liquidation due to owner/partner death
      • - preserve sharelohlder equity/mgmt control due to majority shareholder death
      • - protect against death tax on inherited business
      • - enhance credit/fin stability by assuring business continuation
      • - source of emergency funds
      • - non-qual def comp to attract/retain key employees
      • - EE health/life/dis ins and qual ret plans

• Distribution Channel - network of cos and people that performall mktg activities req'd to deliver products to customers
• 3 types: personal selling/financial institutions/direct response

• Agnecy-Building Distribution Systems
  • Ordinary agency distirbution system - full or part-time agents to sell/service ins pols
    • field force - agents in the system
    • career agent - full-time commissioned salesperson w/ agency contract
    • agency contract - agreement that defines roles/responsibilities/compensation/power of agency
    • power of agency - agents right to act for the insurer
    • Career Agents - independent agents, not employees
      • exclusive agent - tied/captive - not permitted to sell other insurers products
      • agent-broker - broker - places business w/ cos other than primary co
    • marketing territory - geographic area insurer distributes products
    • field offices - sales offices in marketing territory
      • considered a branch office or agency office
  • Branch Office System
    • Branch manager responsible for increaing sales/recruiting and developing career agents/managing expenses for the co
    • Branch manager and office staff are ins co employees
    • Agent in branch office under contract to ins co, not branch manager
  • General Agency System
    • Agency offices established, maintained and funded by general agents
    • General Agent - Independent agent under contract to insurer
      • primary funtion of GA is to build and manage an agency of career agents focused on distributing products of single insurer w/in defined territory
      • GA is agent of insured, not EE
      • office staff EE of GA, not insurer
  • Comparison of Branch Office adn General Agency Systems
    • expensive to build field force from scratch so use GA system
    • GA bears some/all of agency startup costs incl office expenses/salaries
    • Insurer commission costs ~ sales
    • Branch office - high costs @ beginning even though sales low
    • Well established insurers prefer branch office
      • - greater control & flexibiltiy
      • - can transfer personnel between territory
      • - can transfer someone w/ experience vs training from scratch
      • - rewards good producers w/ better territories
    • under GA, need consent of GA to transfer people
    • distinction between GA and Branch office getting fuzzier
• Multiple-Line Agency (MLA) Distribution System
  • uses career agents to distribute life/health/p/c ins for group of commonly managed or financially related ins cos
  • MLAs establish own office w/ little/no help from insurer
  • benefits of MLA system
    • - efficiency in serving certain markets - one agent for all needs
    • - opportunities to cross-sell products
    • - persistency - more business and more satisfied = better persistency
    • - economies of scale for insurer
• Home Service Distribution system
  • exlusive agaents (home service agents/debit agents)
    • defined products/defined territory
    • autohorized ot collect renewals @ PO's home
    • employees of home service co
    • req'd to keep certain hours and may be transferred
  • MDO policy (monthly debit ordinary) - prems collected monthly at PO's home
    • 1k-25k face amts typically
  • PNO policy (premium notice ordinary)
    • $10k/$15k min face
    • prems paid via mail/payroll ded/mbd/eft but may be collected at PO's home
  • usually a district office w/ district manager
  • districts split into territorys - 1 agent/territory
• Worksite Mktg Distribution System
  • individual/grp ins distributed at place of work on voluntary, paryroll deduction basis
  • advantages
    • - effective way to reach and meet the needs of mill/lower income mkts
    • - more cost effective than distribution of indiv plans of ins
    • - builds name recognition
    • - possible gateway to sell grp benefit products to employer
    • - payroll ded less likely to lapse that direct billed for EE who remain w/ company
  • disadvantages
    • - two sales to make - one to employer, one to EE
    • - small face amounts and prems
    • - persistency problems in high turnover workplaces
• Location-Selling Distribution System
  • consumer initiated sales at kiosk/desk in other store
  • may be agency building or direct response dpeending on staffing levels
  • pre-need funeral is a specialized type of location-selling
• Salaried Sales Distribution System
  • relys on salaried sales reps to sell/service products
  • employees of insurer and paid salary
  • Group Representative - handle group sales - specially trained for groups
  • Call and Contact Centers
    • call center - phonebank for support
    • contact center - like phone center but email/mail/phone/web chat
    • possible source of cross sells
• Non-Agency-Building Distribution Systems
  • Pros
    • - don't have to train/finance or provde office support
    • - less expensive to establish
    • - expenses linked directly to sales
  • Cons
    • - agents not exclusive
    • - less control
  • Brokerage Distribution System
    • uses agent-brokers and licensed brokers
    • licensed broker
      • - independent life broker
      • - licensed to sell but not under an agency contract w/ any insurer
      • - responsible for own office space and other expenses
    • producer group
      • - independent producers organized
      • - negotiates compensation/product/service arrangements w/ ins co
      • - normally focus on specific segment of mkt
    • soliciting brokerage business
      • Brokerage Rep
        • appointed to solicit brokerage business and appoint brokers on behalf of co
        • may be full-time salaried employee or soliciting agents
      • Brokerage General Agency
        • agency operated by Brokerage General Agent (BGA)
        • BGA - independent agent under contract w/ numerous insurers
        • BGAs have minimum production reqmts
        • primary function - encourage agents/brokers to sell products of cos BGA represents
      • Wholesaler - broker rep that solicits business for an insu co primarily from broker-dealers adn banks
  • Personal-Producing General Agency (PPGA) System
    • PPGA - commissioned salesperson, not housed in insurer's field office, engaged primarily in personal production
    • most co's that licensse PPGAs have min prod reqs
    • soliciting PPGA business
      • Regional Officer - independt contractor or EE who recruits and manages PPGAs for only one insurer
      • Managing General Agent (MGA) - indepentd contractor typically recruits and manages PPGAs for # diff cos
    • primary advantange of PPGA system - tendency to hold down costs
  • Professional Advisors Distribution System
    • Financial planners/CPAs/Attorney distributing life ins
    • sometimes fee based, sometime commissioned
    • laws and ethics codes are strict for these folks - lots of extra disclosures

• Broker-Dealer (B-D) Distribution System
  • variable products can only be distributed through B-D
  • if insurer want to distribute variable products
    • register ins co as B-D
    • establish sub that registers as a B-D
    • mkt prducts through affiliate that is a registerd B-D
• Bank Insurance
  • distribution of ins to bank customers through bank-affiliated insurer or ins agency
  • authorized by Gramm-Leach-Bliley Act (GLB Act)
• Insurance Companies
  • nonproprietary products - products manufactured by another insurer
  • common products - DI/Indiv Health/small group health
  • done to keep agents/customers happy
  • home-office-to-home-office arrangement
    • HO distributes specific product lines mfg by another insurer
  • career agents allowed to broker on their own for products not carried
  • in-house brokerage agency - solicits dist agreements w/ other cos for prodcuts not offered
    • keeps exclusive agents from dealing with other cos

• overview
  • normally noface-to-face contact occurs - sometimes phone sales reps or agents
  • Direct Response Mkts - using one or more media to elicit an immediate and measurable response from a customer
  • Two types of direct response materials
    • Invitation to inquire - communications designed to generate interest in product/service and provide prospects w/ means to request and receive add'l info
    • Invitation to Contract - communicaton desited to solicit and close a sale
  • fullfillment kit - package of materials designed to address customer's request
• Products Distributed Through Direct Response Marketing
  • generally simple to apply and pay for, u/w, administer
  • typically non-med or guar iss basis
  • non-med basis - sold w/o exam by doc/paramed - may have health questions on app
  • guar-iss basis - no indiv u/w takes place - if an eligible member of group, apply and meets specified contitions, automatically issued a policy
• Media used in Direct Response Marketing
  • Direct Mail - generally print form via mail service - contains mail kit
    • mail kit
      • intro letter response device (application/form)
      • brochures business reply envelope
  • Telemarketing - use telephone to produce sale
    • Outbound Telemarketing - co calls you
    • Inbound Telemarketing - cust call your - usually as a response for other ads
  • Internet
    • Aggregator - site where users can comparison shop many co's for rates
  • Type of Mailing Lists
    • House List - compiled from people who have shown interst in co or been referred by current customers - most productive list
    • Response List - people who have brough from another co through direct response - their house list - second most productive list
    • Compiled List - derived from direcories/newspapers/tradeshow registrations/ etc

• Actuary responsible for product designs and pricing is as much a part of mktg as those more directly involved
• product design adn pricing should not be done in actuarial vacuum, but integral part of total mkt strategy
• must be familiar w/ mkt segment targeted & dist-system used in order to properly price products

• Critical Ins Co functions
  • establishing mkt objectives
  • determing how to grow in mktplace
  • implementing strategies to implent these goals
• mktg objectives s/b designed to maintain existing business and generate NB w/in existing mkts adn from existing dist channels
• growth objectives s/b designed to generate NB from new mkts, new products and new dist channels
• mkt adn growth objectives s/b based on
  • historical results - where co has been, is today, and why
  • strengths - s/b viewed as opportunities and capitalized as either competitive edge or way to enhance profitability
  • weaknesses - eliminated or minimized as much as possible
  • external environment - assesment includes
    • competition
    • consumer needs/desires
    • demographics
    • economic conditions
    • int rates
    • inflation
    • reg climate
    • consumer attitudes
    • gov't intentions (regarding public/private fin security issues)
  • internal assumptions
    • assume sufficient CF & reserves to support sales goals and forays into new mkts, products, dist channels
    • strategic assumptions about how it will utilize capital and other resources
• mktg strategies
  • specific interrelated & complementary activities a co will perform to achieve its goals
  • markets, product, distribution

• specific mkts co wants to operate in
• must be indentified and defined as precisely as possible
• definition includes
  • demographic characteristics
  • geographic location
  • lifestyles
  • motivation
  • needs
  • product use
  • social mobility
• each mkt mustbe measurable (size and purchasing power)
• must be large enough to be profitable and reachable by distribution
• once mkts identified, can plan how to best penetrate these mkts
  • req'd resources, who will implement, time frame

• products offered must be suitable to targeted mkts and dist systems
• must be designed to support mktg adn pricing objectives
• objectives for quality, services and growth s/b met w/in budget adn w/in expense loadign for each product line

• Cos must tailor each dist system to mkt it will serve and products it will sell
• pay attention to what is needed to enhance capability of field & HO to deal w/ new products and to penetrate targeted mkts
• pay attention to how internal programs might impact dist system

• offer assistance to mktg officer in formulation of mktg mgmt objectives and strategies
• gauge potential effects of mgmt decisions
• project expectd results
• take active role in design of product and compensation
• measure progress toward attainment fo mktg objectives
• advise on impact of strategies on fin rating
• advise on appropriateness of sales illustration

• conducting surveys to analyse
  • sales and persistency trends
  • census demographics and econ stats to sales data to id mkt-potential
  • developing conservation programs
  • studying profiles of buyers and products purchases
  • examining trends in buying and paying behavior
  • exploring motivations invovled in various purchases
• conducted both at company and industry level
• study both internal ins environment and external environment
• external environ - demographic,economic, regulatory, cultural, technical trends that may affect ins mkts
  • sources: fed govt agencies, private industry, trade orgs, professional assoc & vendors
• conducted at industry leve by various ins fin services trade orgs and prof ins orgs
• helps senior management in
  • setting company objectives
  • monitoring goals established by such objectives

• montior sales activites and their persistency
• tracked by several measures including product lines and dist systems
• results are used
  • strategic planning process
  • establish mkt share goals adn monitor such goals
  • as performance criteria
  • competitive intelligence process
  • diagnose strengths adn weknesses
  • mkt segmentation purposes
  • motivational purposes
  • measure of the mktg effectiveness of the ins industry
  • problem identification

• Individual Life
  • qtrly and ytd indiv life sales performance trends by dist channel
  • annualized new premium, face amt, # pols, avg size pol, prems/pol, prem/$1m
  • allows cos to compare results w/ others
  • WL/Term/UL/VUL
• Individual Annuities
  • qtrly sales trends by product type
  • deposits for variabel adn fixes annuites, qual/nonqual, single prem/periodic prem
• Individual Health
  • DI - qtrly indiv DI sales by annlzd prem and # pols
  • LTC - new issues and trends in inforce
  • Indiv Health - annlzd prem & pols - medicare supplement, acc, hospitalization, major med, comprehensive
• Buyer Study
  • Indiv life sales observed for trends in variety of product and buyer characteristics
  • provides overall picture of industry
  • hleps w/ design of new products

• helpful to have info on competition w/ mkt share
• analyse using primary (internal company) data along w/ secondary data
  • used to estimate expected growth rates
• sources fo seconday data:
  • US Census Bureau - population and household counts, estimates and projections by area
  • Bureau of Economic Analysis - aggregate personal and per capita income for areas & income proj
  • Bureau of labor Stats - unemployment stats adn workforce size
  • Nat'l Assoc Realtors - housing starts and sales and home values
• Persistency Studies
  • periodic studies for indiv def ann, indiv life, indiv DI
• Consumer adn Field Force Surveys
  • mostly mktg info from
    • analysis of internal operating stats
    • policyholder records
    • trade assoc figures compiled across groups of cos
  • more and more info from own records
  • move from policy records to client records (householding)
  • focus groups can help w/ consumer info
  • industry studies needed for avg ins holding and similar data
• Public in General
  • ACLI surveys American Public
• Sub-Population of the General Public
  • survey of widows/people who recently bought through a bank/etc
  • survey ow policyowners
    • cross section or subgroup such as recently serviced or recently terminated
• Field Force
  • evaluating compensation systems, portfolio, policyowner service, field-HO communication, quality of agent training
  • wants & needs of public - at least agents perception
  • field survey vs field advisory council
    • field survey represents all agents, not just most vocal/top producers
    • field morale improved if ask all
• Caveats
  • surveys can mislead - using info for purpose other than intended
  • surveys are an "art" and trick to get set up adn utilized properly

• two distinct dist systems in US: Agency and Direct Response

• Career Agents - co recruits, finances, trains & sometimes houses agents to represent them
  • field offices - general agencies (headed by GA) and/or branch offices (agency manager)
  • GAs appointed by HO and considered independent contractors
    • usually receive expense allowance to cover office-type expenses
    • responsible for fin mgmt of agency
  • Branch Office - agency mgr gets assignment from HO and directly supervised by HO in fin mgmt of agency
  • difference between GA and agency manager has blurred
• Multiple Line (MLEA) and Home Service Agents
  • usually exclusive relationship w/ HO
  • MLEA also sell P/C products
  • MLEA has much higher agent retentino rate than career agents
  • Home service Agents - generally work in a debit (defined geog area)
    • works in lower-middle income mkts
    • all business is assigned to a servicing agent (eliminates "orphan" problem)
    • commissions generally NOT vested to writing agent

• Brokerage
  • mktg attempt to maintain relationships w/ producers whose primary affiliations are directed elsewhere
  • usually do not finance, train, or house agents who represent them
  • broker-insurer relationship - independent contractor
  • many variations on brokerage - specialized products, substd business, etc
  • brokerage supervisor - HO employee who contracts w/ brokers
• PPGA
  • contracted similar to how brokers are
  • co-employed regional directors (RD), MGAs (Managing General Agents) & direct contact via press
  • RDs and MGAs authorized to appoint PPGAs
  • PPGAs supply own office facilities
  • receive tech assistance in form of computers and adv sales support
  • usually have contracts w/ several cos
  • cu usually has min prod req to continue to receive tech support
• Marketing Organization - co contracts w/ independent org to mkt its products
• Wholesaling - co produces basic product and producer adds fees or commissions
• Producer Groups - groups of high-producing agents agree to place min amts of business w/ a co in return for a share of profits
  • usually through reins or stock options

• Overview
  • major components: FY/RY comm, asset-based comm, bonuses, exp allowances, security benefits
• First Year Commissions
  • expressed as combination of %FY prem, amt/polcy, amt/$1m, %CV
    • usually just % FY prem
    • often annualized & fully vested w/ chargebacks for early lapse
• Renewal Commissions
  • rate of compensation (usually % of prem), pattern of comp, conditions fro payment can be fully, partially, or non-vested
  • reasons for disparate nature of renewal comm scales
    • competitive concerns
    • regulatory constraints (ex. NY Section 4228G)
    • desire to improve persistency
    • direct agent's efforts in manner conducive to co philosophy
  • conditions for payment of renewal comm
    • renewal comm can be viewed as
      • deferred 1st year comp
      • reward for loyalty to co
      • payment (reward) for persistent business
      • payment for service to PO
      • start toward a retirement plan
• Asset-Based Commissions
  • aka trails
  • % of acct value/cash value
  • concept from stock/mutual fund world
  • more common on annuities
  • when on life, usually on UL/VUL products
  • not a significant source of income for newer agents
• Bonuses and other Compensation
  • bonuses focus agents attention on product profitability
  • various bonus measures
    • FY prem or commissions
    • net FY comm
    • total prems or comm
    • persistency (s/t and l/t)
    • # new clients or policies sold
    • combination
• Expense Allowances
  • usually a % of some mesure of slaes
  • sometimes based on renewals/persistency
  • used (in some cases) when agents pay some/all costs of office adn business expenses
• Security Benefits
  • a necessary and important part of overall compensation for career agents
  • includes live ins, health ins, dis, ret benefits, profti sharing, thrift or savings adn 401(k)
  • sometiems includes deferred comp options
  • covered under federal and state laws - OASDI, unemployment, workers comp
  • benefits ~ 16% of agent earnings
  • ERISA - probably biggest impacy adn most important - 1974
  • other acts include:
    • age discrimination - 1978
    • TEFRA 1982
    • DEFRA 1984
    • REA 1984
    • COBRA 1985
    • TRA 1986
    • OBRA 1987
  • FAS106 - 1990 req'd co's to carry retiree benefit costs as liab on fin statements
• Salary Compensation
  • usually restricted to new agents
• Differences Between Brokerage Contracts and Career Contracts
  • career agent usually considered a stat employee adn receives a W-2
  • broker compensation on 1099
  • brokerage contracts - normally no provision for fringe benefits
  • brokers commission schedules generally fully vested and pay rates generally below typical career agent
• Compensation for Internal Replacements
  • common methods for determing first year comm on internal replacemnt
    • % of full 1t yr comm where % increases based on dur of old pol, usually 100% after 10 yrs
    • full comm on increased prem, reduced comm on rest
    • difference between full FY and nwe and old
    • full FY if new prem > 2x old prem, otherwise %
    • full FY regardless

• high front-end commission structures palce persistency risk w/ cos
• level com shifts much of that risk to agents
• aligning agents' interestes w/ co may be what is needed ot arrest churning of business
• problem w/ transistions to level comm structures
  • increase in new agent fin cost since much lower early year comm
  • transitioning existing agents from high FY to levelized
• Possible solutions:
  • option to commute later year renewals to earlier years
  • adding add'l comp to existing business during transition
• Two major challenges
  • what will it cost to make this conversion
  • will change produce overall favorable results to co

• PC(n) - % of companies FY prem producted by agents in nth year of service
• O(n,t) - prob FY prem written by agents in nth YOS is from agents who will leave before policy enters year t
• O(t) - prob FY prem from agents who leave before business enters year t
  • =sum(PC(n)*O([n],t)
• P(t) = prob prem fro year t will be paid
• P(t)O(t) - prob that in policy year t, prem paid and agent no longer w/ co
• r(t) - nonvested renewal comm as % of prem
• cost of nonvested newnew comm = sum(r(t)*v^(t-1)*P(t)*[1-O(t)]
• To calc O([n],t)
  • l(n) = # agents entering nth yos
  • w(n) = # agents w/d from service in yer n
  • wq(n) = w(n)/l(n) = prob agent entering nth yos will w/d that year
  • PRD(n,s) = FY prem produced by one agent during their nth yos who will leave in their n+s-1th yos
  • O(n,1) = 0
  • O(n,t) = sum(PRD(n,s)*w(n+s-1)) / sum(PRD(n,s)*w(n+s-1)) where first term is summed from s=1 to t-1 and second term is from s=1 to infinity

• Overview
  • fundamental purpose of financing - make up difference between income needed (on a fair and resonable basis) and income initially earned under co's std basis of compensation
• Degree of Financing
  • depends on individual curcumstances
  • Aptitude
  • Preliminary Training adn Supervision
  • Company and Agency
  • Type of Commission Scale
  • Annualization of Commissions
  • Personal Circumstances
• Types of Financing Plans
  • Advances - loans made against future comm earnings
    • security against advances
      • comm on all business produced during financing period only
      • comm on all business, past and future, produced by agent
      • all fo agent's assets, incl commission earnings
    • rarely used
  • Subsidy - aka Training Allowance Plan (TAP)
    • payments, on a formula basis, in addition to comm
  • Salary
    • payments made in lieu of part (or all) of earned comm
• Validation Requirements
  • Validation Schedule - contains production requirements necessary to continue agent financing adn/or avoid contract termination
  • 3 basic factors to a validation schedule
    • expected growth rate in agent production
    • avg comm scale expected for financed agents
    • avg persistency and modal mix of business sold by financed agents (usually on premium basis)
  • need to know what to include/exclude from validation req
    • intercompany mktg agreements
    • subsidiaries
    • non-insurance products
  • efforts to reflect indiv performances
    • salary plan that pay comm on sales > validation reqs
    • shift from salary to subsidy plans
    • subsidy plans that pay variable TAP based on performance instead of initial salary level
  • some co's set up drawing accts to smooth out income fluctuations
    • aka line-of-credit plans
• Variable TAP
  • Advantages
    • production driven
    • agent experiences effect of production on income
    • less costly
  • Disadvantages
    • income can fluctuate more than for experienced agents
• Fixed TAP
  • Advantages
    • income stable as production increases
    • strong incentive to produce b/c comm paid
  • Disadvantages
    • high producers not rewarded proportionately
    • production does not have to be smooth
    • income can fall below income needs
• Line-of-Credit Plans
  • Advantages
    • income stable as long as acct cr/dr constant
    • large fluctuations in prod may still yield relatively stable income
    • fairly flexible by incorp adv from other types of plans
  • Disadvantages
    • agent could have decr in income after fin period b/c comm withheld
    • production doesn't have to be smooth
    • more costly due to development and admin
• Salary Plan
  • Advantages
    • Level income regardless of production
    • additional payments if production > certain limits
    • attractive to prospective agents
    • easier for mgmt to recruit
  • Disadvantages
    • high producers not always rewarded proportionately - may cause retention problems
    • costly if agents do not produce @ expected levels but continue on plan
    • income may change considerably when agent goes from salary to comm
    • requires close supervision adn strict adherence to validation scheds
• Estimating Financing Cost
  • avg financing level
  • validation schedule
  • agent retention rates
  • first year prems - estimates should include FY prems by agents who terminate w/in fin period
  • persistency rates and modal dist (freq of prem payments)
  • comm payments and subsidy payments
  • "unvested" recoveries - agents who terminate normally forfeit normally vested commissions on business written during fin period
    • "recoveries" normally subtracted from subsidy payments to determine fin costs
  • example p.IV-22
• Field Management Cost-Sharing
  • provisions for sharing cost and risk of fin new agent usually in GA's contract and now branch managers as well
  • Basic approaches
    • field mgmts share of the cost is highest in early part of fin period
      • discourages hast recruitment and careless selection
      • may carry marginal/failing agents until managers share becomes lower
    • field mgmt's share increases during financing period
      • mgr will continually evaluate prospects for sucess
    • field mgmt assums full cost responsibility from point when agent's production falls below some minimum validation level instead of requiring termination
• Home Office Supervision
  • agencies usually req'd to submitprogress reports on financed agents
• Evaluation of Financing Plans
  • criteria for evaluating effectiveness of plan
    • cost - ultimate excess of total payments over total comm
    • investment - amt outstanding at any time
    • simplicity of operation
    • understandability
    • degree of control
    • correlatoin between benefits and agents performance
    • dist of cost between co and GA or branch manager
    • likelihood of co's new agents meeting validation schedule
    • relationship of validation schedules to co's training porgrams
  • financing plan is ont substitute for training, supervision and sales assistance

• GO or agency manager - vital position in co's mktg org
• many responsibilities incl
  • recruiting/selection of agents
  • agent training/development
  • sales assistance and support
  • 2nd line mgmt development
  • business mgmt
  • agency planning and admin
• agency mgmt pay partly income for doing job and partly reward for taking risk
• five major categories of risk
  • development risk - associate w/ weighting various sources of business and productivity of source
  • persistency riks - assoc w/ payment/nonpayment of renewal prems and conservation of assets
  • expense risk - running the agency w/in certain standard for "controllable" expenses
  • product mix risk - multiple products w/ smaller exp loading and profit margins
  • time risk - delay between "virtuous activities" adn "result" that system rewards
    • may also be stabilization factors adn deferrals which futher separate reward from behavior
• General Ageny vs Agency Manager Systems
  • Theoretical Differences
    • GA is indep dist adn therfore assumes greater business risk in return fro greater l/t reward
    • 3 distinct types of GA contracts
      • general agency contract calls for specific overrideg comm to the GA and provides separately for the soliciting agent's comm
      • company pays comm to GA and PG pays to comm to agents - seldom used today in agency-building situations
      • PPGA contract primarily a producer contract
• Personal Production
  • regualar comm on personally produced business often not a substantial element of agency head's income
  • agency managers historically viewed as sales managers w/ principal responsibility to increase sales of co's products
    • expected to recruit/select/develop career agents whose perforamcne will help co achieve corp growth adn profit objectives
• Compensation Overview
  • Salary - exclusive to managerial systems since inconsisten w/ indep dist philosophy of GA approach
  • First-Year Overrides - motivate new sales
    • most sytems place significant rewards on this component
  • Renewal Overrides - usually paid in a GA system, less freq in a managerial system
  • provides CF stability to a GA and incentive for persistent business
• Vesting - usually subject to vesting provisions that give GAs ownership of future override streams if they leave co
  • originally intended to continue the return of invested capital after GA returned
• Service Fees - common in GA systems
  • orig established to cover prem collection and certain service functions
  • usually not vested
• Bonuses - do not usually vest
  • aka leverage elements
  • ex agency productivity, new agent organization, agency persistency, growth
• Expense Allowance/Business Management Factor
  • GA pays all expenses (in theory)
  • managerial approach - co provides agency office and support
  • GA expenses generally lower since he makes decisions based on actual CF
• Sharing of new Agent Financing Cost
  • loss-sharing assures better supervision and encourages more economical use of co resources

• "nontraditional" for life ins is mainstream in France adn Spain
  • half of US annuity mkt
• high cost of fact-to-face selling by trad ins agents forced most co's to upscale mkt
• middle mkt co's either abandoned mkt or chosen diff dist channel
• nontrad dist channels by mkt
• Middle Mkt
  • worksite
  • banks
  • direct mktg
  • internet mktg
• Upscale Mkt
  • fin planners
  • mutual fund salespeople
  • stockbrokers
  • accountants (CPAs)

• many reps used to be full-time agents in traditional system
• Financial Planners
  • negative perception of life ins agent - many got ChFC or CFA and advertise as fin planners/advisors/consultants
  • objective: to become trusted advisor providing full range of fin advice
  • growing number compensated on fee basis (vs commission)
    • fees: unpront to develop a written plan or asset-based
  • some states allow both fees & comm, some states say either/or
  • few ins cos make fee-based fin planning a primary strategy
    • potential liabilities, admin costs, potential conflict between independent advice and sale of proprietary products
• Stockbrokers adn Mutual Fund Salespeople
  • VAs a natural extension b/c of tax advantages vs stocks/bonds/mutual funds/etc
  • stockbrokers most significant source of VA sales
    • not as sucesful selling life ins
  • grid-based compensation systems - consistent w/ evolving needs of distributors & producers
    • grid approach - gross dealer concession - gross dist margin
• Accountants (CPAs)
  • enjoy high degree of respect and integrity in eyes of ins buying public
  • clients good opportunities for 2nd-to-die life, annuities, and mutual funds
  • traditionally good source of referrals
    • if not selling themselves, expecting agents to split comm w/ them
  • very influential in fin affairs of high net worth clients

• Worksite Marketing
  • aka voluntary benfits
  • mktg personal ins products to EE at their place of work
  • products endorsed by employer that EE decides whether to purchase
  • ER cooperation needed to initiate sales process and implemet payroll ded plan for EE prem payment
  • insurers view as way to reach underserved potential clients in a cost-effective manner
  • agents view as either primary or secondary mktg focus. For both
    • provides daytime selling opportunities
    • large prospecting list
    • fresh "door opener" conversations w/ decision makers
  • EE view
    • discounted rates
    • convenient, non-intrusive slaes process
    • policy portability
  • usually low min prems and guar iss/simplified u/w
  • 3 ways to present and enroll
    • agent (or salaried enroller) meets w/ EE 1-on-1 at work
    • group settings
    • payroll stuffers/direct mail
  • account admin is most critical factor to determining effectivness and success of program
    • depends on ability of payroll deduction
    • systems must be able to accomodate w/o add'l ER expense
  • pricing requires special knowledge and u/w assumptions that allow for attractive profit margins
    • requires close monitoring of actual experience
• Banks
  • increasingly important for annuities
  • 3 main strategies for bank annuities
    • licensed platform staff - specially trained bank employees
    • in-branch (bank) agents - usually work for Bank's ins agency subsidiary
    • third-party agents
  • some mkt annuities through b/d or securities units
  • some use direct mktg methods
  • life ins sales not as sucessful as annuities < 1% total life sales
  • reason for poor life sales
    • regulatory constraints (eased by passage of GLB)
    • u/w process an annoyance banks not used to dealing with (collecting blood, etc)
    • planning for a negative life event vs savings for home or college
    • banks used to transaction sales adn life ins not a transaction sale
  • Compensation
    • most bank producers paid base salary w/ some form of incentive
    • banks hesitant to have sales force paid solely on incentive basis b/c of fear of agressive sales tactics
    • since prospecting not an issue, don't need to compensate for that
    • banks usually compensated by LIC via commission
    • other methods
      • expense reimb & allowance
      • override
      • lease paymenets for use of bank office space
    • incentive for non-licensed bank personnel for lead generation
  • Bancassurance in Europe
    • very succesful in Spain (50%) and France (60%)
• Direct Mktg (aka Direct Response)
  • uses one or more media to elicit an immediate and measurable response
  • records, tracks and analyses that action
  • stores info about action in database for future retrieval and use
  • methods
    • direct mail - tech allows to be highly targeted adn personalized
    • print media
    • broadcast media - select shows/times to hit target mkts
    • telemktg - outbound and inbound (primarily to support other direct response media by processing responses)
    • fax mktg
    • retail centers and kiosks
    • internet dist methods - own site or aggregators
  • traditionally used for consumers not served by personal selling dist systems
    • need only limited or supplemental ins
    • live in geog remote areas
    • need products not widely avail from most co's, agents, brokers
    • need products whose comm potential is too small in relation to an agent's personal selling efforts
  • Tarket mkts also includes indiv who can be easily reached b/c belong to special into or consumer groups
    • company's own customers
    • consumers who have prev inquired about a co's products
    • consumers who have prev inq about another co's direct mktg offer
    • members/vets of armed forces
    • hold dept store or bank credit cards
  • Credit Card holders and SR Citizens frequently targeted

• Persistency
  • Short-term Persistency
    • generally measured using lapse rates based on face/# pols/prem
      • # pols = # decisions to lapse
      • prem - better measure on fin impact
    • most common def of s/t lapse - policy that fails to pay 1st prem of 2nd policy yr (aka 13th mo) for reasons ofther than lapse/conversion
    • early lapse rate stressed b/c
      • fin impact on eraly terminations greater than later terminations
      • early lapse primary indication of if business being sold efficiently
      • early lapses most susceptilbe to chagne by direct co effort
  • Long-term Persistency
    • loss of older business significantly affects profits, div scales and current pricing
  • Establishing Persistency Objectives
    • consider effect of req'd effort on dist channels and on co fin results
    • agents must allot their time between pursuing NB adn servicing old business
      • keeping in mind potential monetary payback
      • if measures to imporve persistency reduce expenses, but production inhibited to point where cost/unit actually increases, no fin gain has resulted
  • Factors Affecting Persistency
    • Income and mode of prem payment are major factors related to persistency
    • MDB close to same as annual b/c of automatic nature
    • buyer-related: higher than average persistency among
      • older
      • professional adn executives
      • already own ins w/ same co
      • insuring lives of juveniles/students
      • initiating sale themselves
    • Product Related: higher than average persistency
      • perm vs term
      • higher prem and/or acct value (cv plans)
      • w/o policy loans
      • u/w on med basis
      • sold w/ insurability option
      • larger PRD policies
      • business vs personal policy
      • issued as applied for
      • sold w/ wvr in home service mkt
    • Producer Related
      • persistency incr as agent's YOS incr
      • new agent terminators sell business w/ poor persistency
      • positively related to agent's product knowledge
      • persistency obnuses have intended effect
      • orphans - good business lost b/c lack of contact
        • poor agents selling poor business
    • Sales Process Related - higher lapses when
      • partial or no cash w/ app
      • needs selling not employed
      • agent stresses savings and thrift
      • policies not deliverd personally to insured
      • post-sale service not employed
    • Related to Outside Environment
      • persistency poorer during high unemployment and high int rates
      • persistency improves when personal savings adn eff buying incomes high
      • growing competition from competitive inv media incr replacements
      • better persistency in mid-Atlantic and Norther part of US
• Replacements
  • reasons why PO may consider replacing existing coverage
    • reduced prems
    • volume discount
    • flexibility
    • interest rates
    • insurer's financial health
  • factors to consider when determining if replacement in PO best interest
    • FY acq expenses
    • Increased prems
    • Values in existing pols
    • suicide adn contestable provisoins
    • new-money plans vs Trad plans
    • tax consequences

• most same info as life
• Persistency
  • measured using surrender rates based on contracts or CV
  • SC relatively effective @ preventing surrender activity when in effect
  • surr rates increase when charges expire (aka shock lapses) & tend to remain higher
  • dist channel has major impact on annuity persistency
  • SPDA shock lapse rates lowest->highest career agents/banks/ind agents/stock brokers
• Replacements
  • reasons to replace annuity contract
    • change of investment risk tolerance
    • cost
    • product perforamnce
    • product features

• loyalty perspective - whole copmany perspective
  • potential for quantum leap gains in persistency
• tweaking - relatively small improvements can have large financial gains
  • financial incentives - sales reps and/or customer a persistency bonus
  • compensation for persistency - reducing FY and increase RY comm
  • continuous educatoin - educate PO about purchased products
    • reduces risk of "escalator effect" - switch products to participate in recent performance of stocks/bonds w/o consideration to their risk tolerance or LT goals

• strategies to combat replacements
  • aggresive pro-active measures by formal conservation unit
  • computerized detection system to indentify internal replacements
  • inform sales reps when policy about to lapse
  • guidelines to sales reps to id potential replacement situations
  • educational materials and sample letters for sales reps to use
  • provide service to former sales reps who service policies
  • compensate sales reps for high retention thru persistency bonuses, incentives, recognition programs
  • do nothing - may be OK for some blocks, but may send wrong signal to field
  • increase face for existing policy. costs s/b offset by improved profits
  • decrease premium for existing policies. costs s/b offset by improved profits
  • set up loan repayment program or exchange program for special cases
  • keep product protfolio attractive and flexible
    • selling good product reduces chance of replacement
  • provide quality customer service

• consumer level - competing against otehr cos w/ similar products
• distribution level - compete for agents or other sales sources
• inter-industry competition - consumer savings and retirement dollars
• mainly focused on price comptetition adn disclosure regs
• price comparison - measures relative attractiveness of pols avail from diff cos
• policy benefit disclosure - informing prospects of structure of policy offered
  • prems, CVs divs, options and supp benfits
• life ins is usually "sold" instead of "bought" - different from most consumer products

• old std basis - net cost = sum prems for 20 years - 20 yr CV - illustrated divs
• 70s - suggesting int adj cost index
  • slow acceptance b/c
    • controversy over choice of new cost comparison system
    • apprehension that emphasizing comparative costs might hampter selling and discourage prospects from buying
    • failure to sufficiently recognize risks of buying needed coverage
    • failure to sufficiently recognize the risks of delay
  • feds started looking @ alternate indexes and spurred cos to react
  • ind adj finally adopted by NAIC in 76
  • myth: cost alone is basic comparison factor among ins products - int adj method perpetuates this
    • doesn't help buyers assess appropriateness of product to their needs
  • consumerists often forget that one of the benfeits for buyer is education and services of a professional agent
  • efforts to improve quality and availability of comparative info ineffectove for several reasons
    • failure by industry leaders (and actuaries) to recognize delay may lead to widespread buyer rejection of ins
    • problems in comparing dissimilar policies - policy types adn company philosophies (new money vs portfolio)
    • agent's ability to vary illustrations - esp int racditing rates
    • actuaries who confuse illustrations w/ projections and reject any form of comparative analysis
    • regulators and regulations that have not kept pace w/ products

• historically used to show effects of dividends
• b/c of external copetition, began using illustrations to show inner workings as comparison to external products
• tech alloed agents to produce illustrations on the fly
• if done on a consistent basis, illustrations provide valid comparison
• abuse of illustrations have caused may problems

• NAIC working group indentified # of computer illustration problems
  • inappropriate use of illustrations to estimate future performance and compare policies
  • lack of accountability of any of the parties to the sale
  • lack of standardized format fo rlife ins illustrations
  • lask of std and consistent definitions, lang, assumptions adn methodology
  • inadequate description of the policy
  • consumers not notified of changes in current assumptions
  • insufficient penalty provisions exist for disclosure violations
  • current regulatory approaches out-of-date considering desings of poliices being sold today
• NAIC Life Ins Illustration Model Reg - app 1995
  • provided for protection of consumers
  • fostered consumer education by making illustrations understanbable
  • provided illustration formats
  • prescribed standards
  • req'd disclosure in connection w/ illustrations
  • created illustration actuary
• Illustration Actuary - certifies illustratoin based on ASB standards
• ASOP 24 provides guidance
• "Illustrated Scale" must be supportable (disciplined current scale)
  • to appease regulators concerns over "bait and switch" scales (non-guar elements)

• policy form should not be supported by another policy form or another source
• accumulated value of policy CF using disciplined current scale and underlying assumptions s/b >= illustrated PO valued for 15th anniv and every illustrated point beyond

• req prohibits illustration of non-guar elements in poliicies deemed lapse supported
• req degined lapse-support test - used disciplined scale assumptions except years 6+ assume 100% persistency
  • intended to insure that any persistency bonuses included in test

• disciplined current scale assumptions s/b based on actual experience to extent experience is current, determinable, and credible
  • otherwise use actual exp/trens of similar blocks from
    • same co
    • other co
    • other sources
    • in above order
• major experience factors
  • interest mortality taxes
  • direct sales costs all other expenses persistency
  • aggregation reinsurance changes in methodology
• model req defines min expenses w/ 3 option approaches
  • approach must be used for all policy forms during certification year
    • Fully Allocated Unit expenses
    • Marginally Accocated Unit Expenses
      • similar to fully but excluded corp overhead adn general adv
    • GRET
  • marginal only to used if > GRET
  • GRET can only be used if > marginal (in aggregate)
  • can always use fully allocated as minimum
  • cannot project favorable trends into future
  • Illustration Actuary needs to certify scale
    • scale has not changed since last certification and experience doesn't warrant changes OR
    • scale has changed since issue only to extent chagnes are reasonably consistent w/ changes in exp assumptions underlying current disciplined scale OR
    • currently payable scale has been made less favorable to PO since last certification and change is more than current experience would necessitate
  • Illustration Actuary should certify annually
    • and for newly introduced forms before new policy form is illustrated
  • certification should contain
    • for business issued in last 5 years, if currently payable scale as been reduced since last cert for reasons unrelated to exp changes
    • statement as to whether inconsistency between illustrated non-guar elements for new policies adn similar inforce policies
    • statemetn whether illustrated non-guar elements for new and inforce pols consistent w/ non-guar element amts actually credited or charged to smae or similar forms
    • statement as to choice of expense assumptions

• 1/s(n|)*[sum([t]P(x)*(1+i)^(n-t+1)) - sum([t]D(x)(1+i)^(n-t)) - [n]CV(x)]
• P - prem, D - Div
• originally 4% in US, 5% in Canada, now 5% in both
• if i=0, Net Cost Index is result
• NAIC model REg Int Adj Payment index - same formula in book, but use 0 for yield

• gibbersih in book

• solves for a level effective int rate or yield
• compares a level prem policy to a term adn invest such that investement @ solved for rate = nth yer cash value

• commonly used w/ "leveraged" COLI policies
• only appropriate for sophisticated buyers

• Actuaries' Index is a "group-average" type adn other methods are "event-specific"
  • "group average" - average cost to a group of PO
• main objection to "group avg" - employs probabilitys that represetn avg and therefore not applicable to many of the buyers who rely on the result
• main objection to "event specific" - likelihood of chosen event occurring is rather small

• N/a to
  • variable life
  • ind and gruop annuities
  • credit life
  • life policies w/ no illustrated DB > 10k
• disciplined current scale - reasonably based on actuarl recent hist exp
  • does not allow projected improvements
  • does not allow assumed expenses < minimums
• illustrated scale - lesser of
  • disciplined current scale
  • currently payable scale
• lapse-supported illustration - disciplined current scale ecxept 100% persistency years 6+
• min assumed expenses
  • fully allocated expenses
  • marginal expenses (only OK if > GRET)
  • GRET
  • if no approved GRET, must use fully allocated
• self supporting illustration - accum CF >= PO value (CV adn other available amts) for 15th policy yer & all illustrated points beyond
  • 20th yer for 2nd to die

• can't use an illustration prior to 1st anniv if policy form marketed w/o illustration
• if mktd w/ illustration, illustration must follow reg
• quotations for non-term group life: show sample age values <> illustration for purposes of reg
  • but illustrated values must be consistent w/ illustrated scale
  • basic illustration must be available to any non-term gruop life enrollee who requests it
• General Rules and Prohibitions
  • labeled "Life Ins Illustration" adn contain basic info
    • name of insurer name adn address of sales rep
    • name/age/gender of prospect u/w/rating class illustrations base upon
    • generic & company prodict name and form #
    • initial DB dividend option election or application or non-guar elements
  • shall NOT
    • represent pol as anything other than life ins pol
    • use or describe non-guar elements in a misleadaing manner
    • state or imply that non-guar elements are guar
    • use a non-compliant illustration
    • use an illustration more favorable than reality
    • provide an incomplete illustration
    • represent that prem payments not req'd to maintain illustrated DB unless that is true
    • use "vanish"
    • use "lapse-supported" illustratino, unless prodcut has no non-f benefits
    • use a non-self-supporting illustration
  • int rate can't be greater than disciplined scale rate

• Format
  • boat load of caveats adn supplemental explanations for anything not guaranteed
  • have date prepared and page # of ##
• Narrative Summary
  • brief descriptoin of policy
  • breif desc of prem outlay
  • brief desc of policy features/riders/options
  • identification adn brief def of column headings and key terms
  • not-guaranteed caveat
• Numeric Summary
  • Pol years 5,10,20,AA70
  • Policy guarantees
  • insurer's illustrated scale
  • "mid-point" scale
    • divs @ 50%
    • credited rates @ avg guar & illustrated
    • non-guar charges @ avg guar & illustrated
• Statements
  • one signed by applicant/PO
  • one signed by sales rep
• Tabular Detail
  • basic illustrations
    • every year 1-10 adn 5th year thereafter
    • any year premium outlay changes
    • prem outlay and mode of payment
    • guar db
    • guar csv
    • non-guar elements may be shown if described in contract
      • must show at same durations
      • must show 0 in guar column

• must be associated w/ basic illustration
• can't show values more favorable than basic illustration
• non-guar caveat
• must include notice to look @ basic illustration

• copy if signed illustration attached to app
• revised illustration need to be signed if policy issued other than applied for
• agent must sign if no illustration used and illustration provided w/ policy
• signed illustration must be kept in file for 3 years after policy no longer in force

• Illustrated policies must provide annual status reports
  • UL
    • beg adn end odate of report period
    • pol value @ end of last and current period
    • total amts credited/debited - by type
    • current Db
    • CSV
    • loan balance
    • lapse notice - if applicable
  • Other Pols
    • current DB
    • ann prem
    • current CSV
    • current DIV
    • applicatoin of current div
    • outstanding loan
  • if pol has no nonf values, only need to supply annual report when change made to non-guar elements

• Illustration Actuary - appointed by board of directors
• Ill Act will certify that illustrations in compliance
• Illustratio Actuary is
  • MAAA
  • familiar w/ illustration ASOP
  • not been bad - from an illustration actuary perpsective
  • disclose material changes in scales/assumptions
  • disclose expense assumptoin
  • certify policy forms annually adn before first use
• another responsible officer certified
  • illustrations in use are ones Ill Act certified
  • co gave agents info about expenses
  • company will promptly inform when and why illustration actuary changes

• professional responsibility of member to public - don't mislead
• familiarity w/ users and uses of sales illustrations - who are users and what is purpose
• determination of range of primary scenarios - ensure ranges are reasonable
  • based on policies, practices adn expereince adn economic environment
• demonstrate reasonable sensitivity - pick an alternate scenario to demostrate sensitivity of policy to changes in experience
• documentation

• historical results s/b adjusted for current factors
  • ex Investment Income Tax, current tax law, current expense levels adn margins for profitability, compensation, etc
• historical results s/b adjsuted for unique/one-side factor
  • impact of declining canadian $ on international inv yields
  • temporary dividend enhancements
• co's intended management of product
• caveat that primary scenario is NOT prediction of results
• scenarios shoudl encompass all exp factory which might materially impact results
• caveat that alternate scenario is NOT worst case scenario
• info on variability of results
• also consider
  • policy provisions
  • company practice
  • potential impact of illustration on PRE
  • ease of implementation of new scenarios
  • whether product is lapse-supported
• consistency between assumptions used in scenario
• consider product special features
• for par dividend scales, consider
  • trends in inv returns
  • compositoin of portfolio of assets
  • investment adn div policies of co
  • recent co experience on factors impacting div scale
• for UL consider
  • guar credited rates
  • LT avg of inv returns by major inv options
  • availability and use of hedging fo rindex-linked inv options
  • guar mort andtoehr charges
  • int credited copared to cgross inv returns
  • recent co experience which might impact spread
• for toher products
  • recent adn anticipated experience in factors affecting results

• co's valn report
• co's long range plan
• economic forcasts
• spot yield curves
• CIA economic statistics
• historical results as reported by organiztions such as S&P, Morgan Stanley, etc

Pricing

• Calc in 3 steps
  • pre-tax solvency earnings
  • deduct taxes to detmine after-tax solvency earnings
  • adjuste after-tax solvency earnings for incr req captial and add after-tax inv income on assets backing req'd capital
• Pre-Tax Solvency Earnings
  • product cash flow - ProdCashFlow(t) = Prem(t) - Ben(t) - Exp(t)
  • adjust for reins if necessary
  • increase in solvency reserves - SolvResIncr(t) = SolvRes(t) - SolvRes(t-1)
  • investment income - InvIncome(t) = PolLoanInt(t) + InvInc(t) + CashFlowInt(t)
  • PreTaxSolvEarn(t) = ProdCashFlow(t) + IncIncome(t) - SolvResIncr(t)
• After-Tax Solvency Earnings
  • AfterTaxSolvEarn(t) = PreTaxSolvEarn(t) - Tax(t)
• Adjustment for Req'd Capital
  • ReqCapIncr(t) = ReqCap(t) - ReqCap(t-1) -> increase in req'd capital
  • ATInvIncRC(t) = InvIncRC(t) - TaxInvIncRC(t) -> after tax inv income on assets backing req'd cap
  • DistEarn(t) = AfterTaxSolvEarn(t) - ReqCapIncr(t) + ATInvIncRC(t)
  • often not practical to price over lifetime of product, instead use 10/20/30 years
  • if n is pricing horizon, need to account for all profits beyond n
    • release req'd capidal @ end of n (ReqCap(n) = 0)
      • either explicitly or set lapse for n to 100%
    • present value of all future events need to flow through year n calc

• solvency reserves distort profit w/ significant NB strain, earnings reserves have smoother pattern, often no loss in first year
• Pre-Tax Stockholder Earnings
  • similar to pre-tax solvency earnings
    • product cf are identical
    • main diff: change in earning reserves (net of DAC) vs change in solvency reserves
    • assume invested assets = solvency reserves + req'd capital
  • PreTaxStockEarn(t) = ProdCashFlow(t) - BenResIncr(t) - DACAmort(t) + InvIncome(t) + InvIncRC(t)
  • DACAmort(t) = DAC(t-1) - DAC(t) where DAC(0) = 0
  • From Solvency Reserves
    • PreTaxStockEarn(t) = PreTaxSolvEarn(t) + SolvResIncr(t) - BenResIncr(t) - DACAmort(t) + InvIncRC(t)

• need to deduct 3 components of tax
  • Tax(t) - PreTaxSolveEarn tax
  • TaxInvIncRC(t) - Tax on Inv Inc earned on assets backing req cap
  • DefTaxProv(t) - Tax on diff between shareholder and solvency earnings excluding II on req'd capital (aka Provision for Def Taxes)
• AfterTaxStockEarn = PreTaxStockEarn(t) - Tax(t) - TaxInvIncRC(t) - DefTaxProv(t)
• Positive Distributable earnings - max amount that can be paid to stockholders
• Negative Distributable earnings - capital contributions stockholders must pay into co
• After-Tax stockholder earnings - earnings reported to stockholders
  • often exeeds distributable earnings for a growing co

• After-Tax stockholder earnings / stockholder equity base
• stockholder equity base
  • stockholder equity @ BOY OR
  • avg of BOY and EOY stockholder equity
• stockholder equity = Assets - Liab
• Assets = DAC + inv assets backing solvency reserve + req'd capital
• Liab = benefit reserves + def'd tax liab
• StockAssets(t) = SolvRes(t) + ReqCap(t) + DAC(t)
• StockLiab(t) = BenRes(t) + DefTaxLiab(t)
• StockEquity(t) = StockAssets(t) - StockLiab(t)
• EquityBase(t) = StockEquity(t-1) or 0.5*(StockEquity(t-1) + StockEquity(t))
• ROE(t) = AfterTaxStockEarn(t) / EquityBase(t)
• ROE varys by year therefore tough to determine if co's ROE goal is met over product lifetime

• basic questions
  • which acctg basis to calc profits
  • how to reflect products degree of risk
  • what rate to discount future values or as targeted rate of return
  • should impact of req'd capital be reflected (authors assume yes)
• Choice of Acctg Basis
  • solvency earnings
    • important to regulators and rating agencys
    • solvency reserve and cap req drive shareholders investments
  • stockholder earnings
    • if co places heavy emphasis on stockholder earnings
    • added difficulty so not as popular
• Reflecing Risk in Profit Goals
  • profit goals related to risk (more risky, higher profit margin)
  • possible ways to reflect risk
    • formula that might reflect lapse/mort/exp/inv risks
    • profit margin set to estimated degree of risk
    • sensitivity analysis to estimate degree of risk and set profit margins
  • examine product design adn origin of assumptinos used to id risks that req special treatment and possibley make design chagnes to minimize risk
• Choice of Discount Rates adn Rates of Return
  • factors to consider when choosing discount rate
    • company's cost of capital - weighted avg and marginal
    • "opportunity cost" of capital - what could they earn if that money was elsewhere
    • current capital position adn expected capital position over next few years - might be receptive to lower yield s/t opportunities
    • how will discounting be used
      • generally based on cost of capital or opportunity cost
      • if discounting to give more weight to early years, pretax or after-tax yields on inv assets may be appropriate
    • rate-of-return rate that discounts the stream of profits to zero
    • it taxes are level % of pre-tax profits, pre-tax and after-tax rates of return are same

• PVPrem = sum(Prem(t)*DiscFactor(t-1)) => t-1 b/c prems paid at BOY
• PV(var,n) = sum(var(t)*DiscFactor(t)) over n years
• if some PVFP < 0 [ i(t) - normal disc rate j(t) - discount rate when profits are neg - typically after-tax int rate earned on invested assets]
• PVFP(n) = Profit(n)
• for t = n to 1 step -1
  • If PVFP(t) > 0 then
    • PVFP(t-1) = PVFP(t)/(1+i(t)) + Profit(t-1)
  • else
    • PVFP(t-1) = PVFP(t)/(1+j(t)) + Profit(t-1)
  • endif
• next
• PVFP(n) = PVFP(0)
• if n = 1, Profit(0) = 0

• Overview
  • Embedded Value Return on Investment (ROI) Weighted-avg return on equity (ROE)
  • Profit as % of Prem/Assets/revenues/risk charges
  • Accum Porift at % of reserves breakeven year new business strain
  • most co use ROI or ROE along w/ profit as % of prem
  • publicly traded stock cos tesnd to use embeddev value, ROI/ROE as one of their profit goals - each involves a targeted rate of return
• Embedded Value (aka value added)
  • simplest measure - only one decision - hurdle rate
  • hurdle rate - rate of return owners expect
    • s/b in line w/ weighted avg cost of capital for stock co
    • s/b consistent w/ return avail on investments of comparable risk
  • normally base profits on after-tax solvency earnings or distr earnings
  • distr earnings better reflect owners' expected cash flows
  • EmbeddedValue(n) = PV(Profit,n)
• Return on Investmetn (ROI)
  • solved for discount rate that causes PV Profits = 0
  • normally base profits onafter-tax solvency earnings or dist earnings
  • Dist earn preferrable - better reflects owners' expeced cash flows
  • ROI can be primary or seconday profit goal
  • ROI fails if all policy years are profitable
  • posses in later years can olso produce meaningless ROI
  • Simple ROI
    • 0 = sum(Profit(t)/(1+i)^t and solving for i
  • Multiple ROIs
    • # positive roots of polynomial = # sign changes of Profit(t)
  • Generalized ROI
    • if muliple sign changes, use an int rate for borrowed money (j(t)) adn use iterative process to solve for i
      • PVFP(t-1) = PVFP(t)/(1+[i(t) or j(t)]) + Profit(t-1)
• Weighted-Avg Return on Equity
  • calculate a weighter avg return = (after-tax stockholder earnings) / weighted avg equity base
  • can weight by discounting using ROI goal or hurdle rate
  • can link to targeted growth rate
  • WtdAvgROE(n) = PV(AfterTaxStockEarn,n) / PV(EquityBase,n)
  • hopefully each policy year ROE approx = WtdAvgROE
• Profit as Percentage of Premium
  • one of most common profit measures
  • advantage: fairly concrete and easy to explain
  • common to use pre-tax or after-tax int rate eaerned on assets for discounting
  • using ROI or Hurdle rate, PVProfits approx = 0 therefore meaningless
    • this logic applies to all measures that compare PVprofit to another measure
  • Proft%Prem(n) = PVProfit(n) / PVPrem(n)
• Profits as Percentage of Revenue
  • generalization of Profit%Prem
  • useful mainly as way to compare relative profitablilty of similar product types
  • NOT useful at comparing two diverse products
  • not all products use premium as important soure of revenue (ex. UL -> inv income and charges)
• Profits as Percentage of Assets (aka Return on Assets or ROA)
  • many product priced w/ targeted spread between rate earned and rate credited
  • useful to know how much of spread (on avg) retained as profits
  • numerator and denominator need ot be in sync
    • after-tax solvency earnings <-> solvency reserves
    • dist earn <-> solv reserves & req'd cap
    • after tax stock earnings <-> solv resv & req'd cap & DAC
  • ROA(n) = PVProfit(n) / PV(Assets,n)
• Profits as Percentage of Risk Charges
  • Risk charges -attempt to quantify degree of risk inherent in product
    • may consist of mortality, lapse and inv components
    • simpler: risk charge as % or req'd capital (assuming req'd capital is accurate measurement of risk)
  • no std approaches
  • PVProfits(n) / PV(risk charges,n)
  • attraction: compares profit to risk
  • detraction: may be illusion since risk charges somewhat arbitrary
    • difficult to explain concept to management
  • Risk-Free Rates and Risk Charges
    • investors want higher reterns for higher risks
    • minimum rate of return for risk free investment
    • goal to developing meaningful risk charges - profits net of risk charges earn risk-free rate
    • w/ PV based on risk-free rate, PV(Profits) = PV(Risk Charges)
    • use industry avg rates of return to establish appropriate level of risk charges
      • ensures pricing roughtly in line w/ rest of mkt
• Accumulated Profit as Percentage of Reserves
  • one of earliest profit goals - primarily mutuals
  • goal - one generation o