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Pricing and financing strategies (Ways of financing pension scheme…
Pricing and financing strategies
Actual cost of benefits
Basic level
Value of premiums= Value of benefits + value of expenses + contribution to profit
Other factors
Tax
Commission (if not already included as an expense)
the cost of any capital supporting the product
margins for contigencies
the cost of any options and guarantees
the provisioning basis
experience rating
investment income
reinsurance
Cashflows in respect of provisions and solvency capital requirements
The increase in provisions and solvency capital requirements should be shown as a negative cashflow.
The investment return on the provisions and solvency capital requirements should be shown as a positive cashflow
e.g.
(+) premiums
(+) investment income (on premiums - expenses + reserves)
(-) expenses
(-) benefit payouts (claims, maturity, surrender values)
(-) increase in reserves
= profit gross of tax
Impact of a high solvency requirement on profits
A high solvency capital requirement will defer the emergence of the profits
This is because the cost of establishing such capital will be greater early in the life of the contract, but the releases if this capital will be greater later in the life of the contract.
The total profits emerging do not depend on the solvency capital requirements, it is purely the timing of their emergence that changes.
However, a deferral in the emergence of profits will result in a lower NPV of profits if the risk discount rate exceeds the assumed future investment return, as would normally be the case.
This would potentially result in a higher premium, if a given profit criterion is being targeted.
Why price may be different from cost
The provider's distribution system for the product may enable it to sell above the market price, or to take advantage of economies of scale and reduce the premiums charged.
The provider might have a captive market, such as an affinity group, that is not price-sensitive
A cheaper price might also be as a result of the provider taking a lower or no contribution to expense overheads and profit. (No contribution to overheads = marginal costing.)
Loss leader: a cheap product may attract customers to other, more profitable products of the company
Underwriting cycle: there may only be a limited number of providers in the market and so higher premiums can be charged. Alternatively if there are lots of providers are in the market, premiums will fall.
Ways of financing pension scheme benefits
Pay-as-you-go
Smoothed pay-as-you-go
Terminal funding
Just-in-time funding
funds are set aside only in response to an external event such as a sale of employer.
Regular contributions
Lump sum in advance
Why actual contribution rate might differ from the calculated theoretical cost of benefits
In surplus or deficit
The sponsor may want to alter the pace of funding by paying a higher or lower contribution in any year.
There might be legislative restrictions (upper and lower limits) on contrbutions.