Chapter 9-With-profits surplus distribution 1 Flashcards
List 3 forms in which profits can be distributed to with-profits policyholders
And give examples of which of these will be best suited to meet different customer needs.
Addition to benefits
- if the policyholder has a use for the ultimate policy benefits
- desire to save
- need for lump sum to be adequate to meet the required need at payment date
Cash bonus
- large amount of assets to invest now but little future income supply
- single premium with-profits endowment - supplying income while lump-sum benefit on maturity or death will protect capital
Reduction of premiums
- fixed monetary liability at a future date (loan repayment)
- reductions in premium will keep the cost of the loan repayment to a minimum
List the possible constraints that may prevent an insurer changing the way they distribute profits
- legal requiement (prevents profits being distributed in a certain way)
- PRE’s - market may not be expected the new approach (marketing pressure)
- Competition - product may appear uncompetitive (marketing failure)
- Systems limitiations - different data required (conversion expense prohibitive)
- Management Limitations - different techniques and exptertise
- Articles of association - conditions set out that dictate how profits must be distributed
Explain why the insurer and the with-profits policyholders may have differing views on deferral of distribution of profits to policyholders
From insurer’s point of view, deferral of distribution may be attractive because:
- increased probability of remaining solvent (reduces risk)
- greater investment freedom ( future bonuses higher if earn higher returns)
- the approach of underpaying bonuses to provide a larger terminal profit distribution may be relatively unpopular with policyholders and will make marketing more diffcult
With-profits policyholders may welcome second of these (higher future bonuses), but possible disadvantage of deferral may be:
- uncertainty of not knowing how much deferred (terminal) distribution is going to be
What is it that forms part of the profits distributed?
What split/factor is it important for us to consider when deciding on profits to distribute?
Profits usually constitute
+Excess investment return on premiums paid over the guaranteed return
+Mortality/expense profit - extent to which these will be distributed will depend on the distribution method, country, insurance company
Usually less significant than investment profit, because
+long term mortality/expense experience can be more accurately predicted than investment performance and
+premium basis can be based on more realistic forecast of future mortality and expense assumptions
Whether or not with-profits policyholders are entitled to profits made on “non-participating”policies (without profits and unit linked).
Important to consider split between
+profits distributed to shareholders vs profits distributed to policyholders
+may be regulation restricted/governed
Name 3 surplus distribution systems
Additions to benefits
+conventional with profits
+accumulating with profits
Revalorisation
Contribution
Describe the additions to benefits approach
And list the 3 kinds of bonuses that can be used to increase the initial sum assured under this approach.
Profits are distributed in direct relation to the current benefits under each contract.
Kinds of bonuses:
- regular reversionary bonuses, added throughout the contract term
- special reversionary bonus, added as a “once off” from time to time
- terminal bonus, paid when the contract reaches maturity (and possibly also on death or surrender)
Define reversionary bonus
And outline the differences between regular and special reversionary bonuses.
+Declared during contract lifetime, payable at the same time as basic benefits
+Once declared, is attached to basic benefits and cannot be taken away
+Can be regular (usually added annually), or special (added as once off from time to time)
+Bonus is defined as some proportion fo the benefits currently payable on a claim
Regular reversionary bonus:
- reversionary bonus that is declared on a regular basis (usually annually) throughout the lifetime of the contract
- once declared it becomes attached to the basic benefits and is guaranteed
- simple, compoun, super-compound
- rates not guaranteed, but there is an expectation that insurer will continue to pay them and that the rates will not change too much too quickly
Special reversionary bonus:
- part or all of a reversionary bonus declared as a one-off special (in addition to any regular reversionary bonus)
- no expectation that a similar increase will be granted in the future
- suitable for distributing any one-off profits (restructuring of with-profits fund, demutualisation, takeover)
Describe the 3 types of regular reversionary bonus for conventional with-profits policies
Simple: bonus expressed as % of basic benefit
Compound: bonus expressed as a % of basic benefit plus any already attaching bonuses
Super compound: bonus expressed in terms of two %s one applied to basic benefit second applied to any already attaching bonuses. Second percentage usually higher than the first.
For given total amount of reversionary bonus at maturity date of an endowment, deferral of distribution is greatest (more capital efficient) with super compound, and least with simple bonus
Define terminal bonus
State 2 ways in which it can be speficied for conventional with-profits policies
Terminal bonus
+Additional amount payable when insured event occurs.
+Determined when insured event occurs.
+Insurer will not guarantee to maintain the bonus at any particular level
+Generally more volatile as company has greater scope to increase if needed.
+Great advantage is that it defers the distribution of surplus and slows down the build-up of guarantees
+Useful for distributing profits that come from volatile sources
TB may be specified as:
% of total attaching reversionary bonuses (including any special reversionary bonuses), possibly varying with duration in force and original term of contract
% of total claim amount (basic benefits plus attaching reversionary bonuses) before addition of terminal bonus, with the percentage varying accordign to duration in force
- terminal bonus set to be equal to the difference betweeen the asset share and benefits guaranteed to date at policy maturity date
What kind of profit sources are terminal bonuses usually used to distribute?
What is the general/guiding principle used to determine the level of terminal bonus to distribute?
Profit source distributed by terminal bonus
- Usually used to distribute profits from more volatile sources rces e.g. capital gains on equity
Usually set as difference between asset share and guaranteed benefits
- because aim is to distribute profits to policyholders, allowing for shareholder’s interest and other aspects such as cost of capital.
- insurer tracks asset shares of sample policies to determine if affordable terminal bonus.
Explain what is meant by accumulating with-profits (AWP) contract
Definition
Bonuses are added annually in relation to premiums paid to date plus previously declared bonuses
Premiums regular or single
Terminal bonus may be added when policy becomes claim
May be unitised or non-unitised
What is the key difference between conventional with-profits and non-unitised accumulating with-profits contracts?
Relationship between each premium paid and addition to benefit to which it gives rise is:
+Explicit for AWP contracts
+Implicit (the premium rate) for CWP contracts
Level of guarantees also tends to be greater for CWP contract:
- because bonuses are declared on the current benefit rather than on the sum assured for AWP
- but if less surplus is held back for terminal bonus for AWP, then guarantees will be increased
There may be a guaranteed minimum rate of accumulation for AWP contracts ( but is rare for new contracts)
What are the key differences between unit-linked contracts and unitised accumulating with-profits contracts
Unit price
- UL: set objectively by direct reference to value of underlying
- AWP: set at discretion of company, so only indirect link with value of underlying assets. Insurer will take loner-term view of investment returns and smooth the bonuses that is allocates.
Surrender values
- UL: bid price of allocated units less any surrender penalty specified in contract. Company has no discretion.
- AWP: bid price of allocated units plus terminal bonus (if appropriate) less any surrender penalty specified in contract less any MVR that company may have right to apply
Describe 2 basic ways in which the unit part of a unitised accumulating with-profits contract could operate
(1) Unit price remains constant e.g. R1.00 and bonuses are granted by allocating additional units company allocates additional units to each contract, usually annually at bonus declaration.
these are made up of (possibly zero) guaranteed addition, and bonus addition, which could also be zero especially if there are guaranteed additions number of units is determined at discretion of company
(2) Bonuses are granted by increasing unit price, usually on a daily basis.
increase is made up of (possibly zero) guaranteed part and bonus part. increase in UP is at discretion of company
Under both methods, terminal bonus could be added when claim event happens
State 2 possible charging structures for unitised accumulating with-profits business
and give 5 examples of possible charges
Explicit charging e.g
+policy administration charges
+percentage allocation during an initial period
+bid/offer spread
+charge for risk benefits
+annual management charge
Implicit charging e.g. through choice of bonus rate
