Unit-Linked Business Issues

Transcription

1 Unit-Linked Business Issues By Michael Ross W W W. W A T S O N W Y A T T. C O M 15 November 2005

2 Introduction Introduction This presentation discusses some of the important issues surrounding unit-linked business in Hong Kong in terms of Reserving, Treating customers fairly, and Unit pricing and how this might relate to treating customers fairly 2

3 Background to the market W W W. W A T S O N W Y A T T. C O M

4 Background Introduced in late 1980 s into Hong Kong. Sales appeared to be limited and mainly through the offshore insurers. Basic products were developed by local companies but appeared to have limited success. Volatility of the investment market Guarantees considered important People preferred to do their own equity investing Concerns over selling practices Cost of introducing these products and whether the market was ready for them 4

5 Linked and non-linked (new business premium) Linked and Non-Linked New Business Premium Growth Premium (in Millions) 25,000 20,000 15,000 10,000 5,000 60% 50% 40% 30% 20% 10% Percentage of Linked Busines Year Linked Non-Linked Linked % 0% 5

6 Linked and non-linked in-force (premium growth) Linked and Non-Linked Inforce Business Premium Growth Premium (in Millions) 60,000 50,000 40,000 30,000 20,000 10,000 35% 30% 25% 20% 15% 10% 5% Percentage of Linked Business Year 0% Linked Non-Linked Linked % 6

7 Linked and non-linked in-force (by reserves) Linked and Non-Linked Inforce Business Reserves Premium (in Millions) 180, , , , ,000 80,000 60,000 40,000 20, Year 35% 30% 25% 20% 15% 10% 5% 0% Percentage of Linked Business Linked Non-Linked Linked % 7

8 Reserving W W W. W A T S O N W Y A T T. C O M

9 Unit reserves Can be calculated using aggregate or seriatim basis No. Units fund i * Unit Price fund i All i Any outstanding cash not included in the unit fund. How does this compare with the fund value on the asset side of the balance sheet Simple exercise? 9

10 Requirements under AGN3 3.4 For investment-linked business, the Appointed Actuary has to consider the following factors in performing the cash flow projections: the effect when an investment-linked policy ceases premium payment, whether the fee or charges are guaranteed or not, whether the allowance for fee or charges receivable in the future are sufficient to cover the assumed future expenses, whether the cost of insurance charges are guaranteed or not, whether the insurance charges are sufficient to cover the assumed future mortality and morbidity cost, and whether the contract provides any bonus or options. Does the previous method do this? Non-unit reserve 10

11 Requirements under AGN3 3.4 Unit growth rate + Expenses and expense inflation rate Realistic risk discount rate Prudent assumptions Extra reserve 11

12 Requirements under AGN3 3.4 Allowed to take account of discretionary charges What will policyholders expect? What if the policy were paid up? Can the changes be implemented immediately? Loyalty bonuses? What happens if fund value changes? 12

13 Non-Unit Reserves (Sterling reserves) Using cash flow approach, with following steps: Project the expected future cash flow from valuation date, ie income from charges less outgoes using prudent assumptions. Identify the last (ie most distant) negative cash flow (say this is at time t) Set the reserves as an amount needed to cover that cash flow at that point in time Move back to the previous cash-flow (ie to time t-1). Discount the reserve from time t to time t-1, and then subtract from the reserve at time t-1. Set reserves to zero if it becomes negative Carry on repeating the process for t-2, t-3, etc until valuation date 13

14 Treating customers fairly W W W. W A T S O N W Y A T T. C O M

15 Treating customers fairly New issue Related to selling practices. Look at what is happening in the UK and whether we should be applying this to HK Cover both unit linked and non-linked business, but does raise some important issues about selling policies in HK? 15

16 What is fairness? In the UK there is now much discussion on treating the customer fairly. Why Key to the operation of an efficient retail market for financial services. The fair treatment of customers is central to consumers having confidence in the financial services industry. Will this issue come to HK? Look at what happened in Singapore at the start of 2005 where the newspapers started to question the charges regarding unit linked policies. Felt could have been avoided with better disclosure including better designed annual statements, projection of the charges each year, better handing of the complaints when they arose rather than having to deal with them through the press. 16

17 What is fairness? The FSA believes that in the market place treating customers fairly should be an important element (alongside service levels, pricing and customer satisfaction) in determining the success of a firm in acquiring and maintaining market share. Services both customer s and other stakeholders interest. However in many markets for retail financial products and services the incentive structure for firms to treat their customers fairly has not always been robust enough to deter all firms from inadvertently or deliberately taking advantage of the relative weakness of the financial services consumer. 17

18 TCF is a key strand of the FSA s objective of consumer protection Desired outcomes for the retail market Customer needs understood Financially aware consumers Financially sound firms & economically sustainable distribution Customers treated fairly Customer needs project National financial capability strategy Basel Sandler simplified selling regime Treating customers fairly Financial promotions Depolarisation Complaint handling Mortgage and general insurance regulation EU distance marketing directive Principles and practices of financial management (PPFM) Effective and proportionate regulation: ARROW assessment process Product risk framework Source: FSA Treating customers fairly July

19 A principles based approach Corporate strategy Culture Understanding target markets Product design and management Marketing and promotion Sales and advice After sales service Customer feedback (including complaint handling) People management, behaviours and incentives Management information Underpinning the FSA s principle-based approach is that the responsibility for ensuring customers are treated fairly sits squarely with individual members of the senior management 19

20 How active is your organisation in addressing TCF? No response yet 0% 9% General Insurers Life Providers Minimum requirements being addressed 8% 5% Follow best practice when defined 9% 38% Proactive, but not publicised 38% 68% Playing leading role in industry 9% 16% 20

21 What is the biggest internal challenge to the success of TCF? Other Extent of TCF across business 7% 5% 7% 5% General Insurers Life Providers Senior mgt buy-in 25% 29% Delivering cultural change 0% 20% Knowing what to do 30% 43% Availability of resources 14% 15% 21

22 Who is leading the TCF initiative in your organisation? No One 12% Other 0% Senior Manager 35% Function Director 6% Board Director 35% CEO or MD 12% 22

23 Which function has been given responsibility to lead TCF in your organisation? No One 0% Other 6% Sales 6% Customer Services 0% Multi Discpline 22% HR 0% Marketing 28% Compliance or risk mgt 38% 23

24 Can you achieve a competitive advantage through TCF? Strongly Disagree 0% 10% General Insurers Life Providers >70% of general insurers 14% Disagree 10% 60% of life 14% insurers 20% Don't know Agree 35% 50% Strongly Agree 22% 25% 24

25 The carrot and the stick Because of the wide range of activities carried on by authorised firms, it is not possible to define TCF in a way that applies in all circumstances. Making more detailed rules would also restrict the freedom of firms to form their own views about how to treat their customers fairly, without necessarily improving consumer protection. While we recognise that it will be a challenge for us and firms, we are aiming to maintain a principle-based approach which will give firms greater flexibility over how they can best meet the requirements of TCF. Failure to treat customers fairly may lead to enforcement action resulting in a public censure or a penalty. Source: FSA 25

26 Challenges Principles based regulation principles based solutions Driven by company interpretation of, and attitude to, fairness Particular areas Culture Management information Provider/distributor interface 26

27 Will TCF require a cultural change in your organisation? No change 14% Moderate or above 4% General Insurers Life Providers Minimum change 36% 50% of general insurers 17% Moderate change 21% 79% of life insurers 30% 29% Significant change 39% Total mindset change 0% 10% 27

28 Management information What are true measures of fairness? Satisfaction, but TCF is not about being nice to customers Retention but how valuable in long term business? Customer expectations Fairness = customer service Fairness = ethicality Fairness = competency 28

29 Providers and distributors the old model? Provider Understanding target markets Product design and management Marketing and promotion Sales & advice After sales service Distributor 29

30 Providers and distributors new reality? Provider Understanding target markets Product design and management Marketing and promotion Sales & advice After sales service Distributor 30

31 Issues in Hong Kong Illustrations and whether they are realistic The illustration of the asset charge and are we being fair. Show the asset charge separately Do clients understand this point? Front end and back end charges Do clients understand? Do the distributors understand? Are we really offering investment advice? Where is the vanishing point of the policy Term verses saving? 31

32 Unit pricing W W W. W A T S O N W Y A T T. C O M

33 Unit pricing best practices In the UK the Association of British Insurers have issued a draft guidance note on unit linked funds called a guide of good practice for unit linked funds Asking for comments Arose from the guiding principle that firms must act in accordance with the concept of Treating Customers Fairly Fund governance The board Management committee Appointed actuary Internal audit and compliance 33

34 Why be worried about unit pricing APRA Directs XXX Life On Unit Pricing Issues The financial regulator has given directions to the Colonial Mutual Life Assurance Society Limited (CMLA) with regards to its unit linked life insurance products, following unit pricing errors made by the company Total Bill For Pricing Errors Stands At A$24.5 Mln has to pay a total bill of A$24.5 million (US$18.8 million) for its pricing errors and has voluntarily provided an Enforceable Undertaking to the Australian Securities and Investments Commission (ASIC) to compensate the affected investors. Is unit pricing important 34

35 Policy conditions Expect the policy conditions to cover: How and when value is assigned to each asset Deductions that can be made from the funds and how they are calculated Charges Allowance for tax (if applicable) The basis on which the company can create or cancel units in a fund The calculation of fund prices Allowance for selling and buying costs The basis for transacting with policyholders 35

36 Discretion in managing the fund Funds should operate according to published criteria and standards The scope of the firms discretion in managing the fund and the limits to that discretion should be documented and disclosed to policyholders The scope of the discretion should be confirmed annually with a more significant review every three to five years Areas where discretion can apply include: Launching funds and seeding of shareholders capital Allowing for dealing costs Unit pricing rounding Precise definition of annual management charges Tax Introducing charges for new and unforeseen types of expenses Merging funds Internal deals between funds Ability to defer switches/surrenders Ability to defer transactions by customers seeking to exploit market timing opportunities Ability to close a fund to new business or switches in Basis for valuing assets Choice of pricing point Frequency and time of pricing Breach and dispute resolution 36

37 Standards Overview Unit prices calculated and applied in a properly controlled environment Fair terms for unit holders Consistency in the method to allocate and de-allocate units to policyholders Consistent method in creation and cancellation of units Expenses, income and any taxes recognised appropriately Accrued in timely fashion so as to remove artificial volatility in price 37

38 Pricing model Forward pricing Calculating the price at which the transaction is undertaken after the deal is done so as to establish the true value of the units at the time of purchase or disposal Eliminates the risk of any potential mismatch between the dealing price and the value of the underlying units Historic pricing Transactions undertaken on the basis of a known, quoted price at the time the transaction is done, based on an existing, or historic, valuation of the assets in the fund Attraction of allowing customers to deal at a known price Can be simpler and easier and cheaper Where the company is dealing within a fund usually done on a forward-pricing basis 38

39 Pricing frequency and timing Need to consider the following points: Avoid losses to policyholders through market timing and other strategic dealing activity Level of liquidity managed to avoid any significant, unintentional gearing or dilution effects Avoid any material loss to fund or policyholders by ensuring a good match between net policyholder unit transactions and the related asset purchase or sale There is no undue delay between receipt of a trading instruction for a policyholder and the resulting unit transaction Pricing frequency disclosed to policyholders Switching between bid and offer so as to avoid any significant dilution where the new flow of investments changes Switch the pricing basis where material changes in flow of funds occurs 39

40 Valuations Value of assets at recognised, independently assessed prices If no market valuation is available then who is responsible? Rounding Necessary process used to simplify the pricing of unit linked funds Have an established approach clearly defined and monitored What is good practice? Kept to a minimum Neutral basis Not used to extract value out of the fund Dealing costs clearly disclosed to policyholders Allowance often made in the unit pricing 40

41 Error correction Make all reasonable efforts to ensure that mistakes in administration do not occur Where they do occur they must be quickly identified and any systemic issues rectified Compensation should be paid where appropriate Where an error is identified price should be corrected and published without delay No phasing in or smoothing Timely payment of compensation 41

42 Michael Ross Director Watson Wyatt Insurance Consulting Limited Telephone (852) W W W. W A T S O N W Y A T T. C O M Fax (852) Michael.ross@watsonwyatt.com