A model to design and price an income protection product on diagnosis of permanent disability and critical illness
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The major objective of this study was to design and price an income protection product payable for 3 years in annuity form upon diagnosis of permanent disability and a lump sum on diagnosis of critical illness. Specific objectives of the study were to design a product with affordable premiums, design a product that achieves a profit margin of at least 5% and to carry out sensitivity analysis to establish the most significant values that affect the profit margin. To achieve the objectives of the study, profit testing pricing technique was used where various actuarial computations were carried out to determine the premium amount for different terms and ages. The key assumptions made include; - risk discount rate of 8.5% per annum, interest rate of 9.5% per annum, surrender rate of 15% per annum, operating expenses of 10% and income replacement rate of 60% of net income among others. The sum assured was obtained as the expected present value of expenses and benefits from annuity payments which was in turn used to determine the premium result for projecting the possible future cash flows associated with this product to ascertain whether it’s profitable. The results of the profit test shows that this product is more profitable with female lives at young ages (18-20years) and above47years while male lives are more profitable between ages 20-47years. Profitability is observed to be highest for policies of around 7 – 15 years and is low with periods below 7 years. It is also observed that the annuity incorporation reduces on the premiums to be paid hence affordability of the product. The results also show that a life earning a monthly net income of 1,000,000 will receive a monthly annuity payment of 600,000shs hence achievement of the major objective of the study. Furthermore, the results achieve all the specific objectives of the study since for terms 5-15years, the premiums paid constitute to between 1%-20% of one’s annual net salary making it affordable and also the product achieves a profit margin of at least 5% (i.e. least margin is5.297217%). Also, sensitivity analysis shows that Withdraw rates and expenses are the most sensitive assumptions. In conclusion, the addition of annuity on endowment boosts profits and thus would be good for a given company. However, more sensitive assumptions i.e. discount rate and expenses should be monitored more regularly and re-pricing done if they go very far from the acceptable range since they are the most significant values that affect profit margin A mixture of gender, terms and ages should be considered in order to eliminate their effect on profitability as this would strike a trade-off between age and sex differences since male lives are more profitable than female lives between ages 18-24 and above age 47 while female lives are more profitable than male lives between ages 25-47. Also more research can be carried out to avoid any chance of loss.