It has been more than 20 years I learned about Profit Testing in life insurance which I acquired during my college years in University of Iowa and ever since I had almost never apply in during my entire career. Nevertheless, I had the opportunities in several occasions, seen and being briefed pertaining the outcome of profit testing mainly on development of new life products as well as takaful products.
Now I have an opportunity to digest the entire technical aspects of profit testing as I need to present to a group of students on the same subject matter. Interesting and challenging enough..... For the benefit of readers, I summarize as below.
Profit testing basically a cash flow studies on the life insurance product as well as family takaful product on the future cash in and cash out. Besides, the investment income and inflation shall also be taken into consideration during the process of calculation. In a nutshell, the profit testing demonstrates the expected scenario in the future till the maturity of the policy pertaining the premium/contribution income, investment income (cash in) against expenses paid, commissions, taxes, reserves, claims benefits including death and living benefits. Therefore, the actuary must ensure that all the factors used in the testing must be prudent or extremely accurate based on extremely good judgement. The outcome of the testing will lead to a decision whether to proceed selling or promoting the product or not. Obviously, if the testing indicates a profitable outcome then it is worth to sell/promote otherwise the product shall be redesign accordingly.
However, the actuary shall conduct the testing again say on year to year basis against the actual experience of the company. For instance, he has to test the impact of actual investment income against the assumption used. Similarly, he may have to test against the expenses actually paid out which may differ from the assumption. This is the part where most people failed to exercise i.e. re-testing the products.
Besides testing on individual product basis, actuary shall also conduct profit testing on the life office model or takaful office model. This is to ensure that the entire portfolio of the company is healthy for the future growth of the company. Just to share some experience, there are instances where the agents loved to sell/promote health and medical scheme or plans as they are so easy to sell. Some smart agents even setup a 'permanent' station or booth somewhere within hospital or medical centre compound and start their normal persuading and convincing activities. In one aspect it is a good move but on the other aspect it may lead to huge number of non-std lives insured. Obviously, claims will arise as the actual experience of morbidity is far beyond the standard assumption used in the pricing. Finally, the portfolio is a losing account. It may be OK to have a losing account or portfolio sometimes as it is just a complimentary to other plans. Insurance or takaful needs to embark on corporate social responsibilities as well besides profit, profit and profit. Of course, one of the activities for CSR is offering plans highly needed by the consumers.
