Chapter 10-With-profits surplus distribution 2 Flashcards
Describe the revalorisation system of surplus distribution
Bonuses are granted by increasing reserves, benefits and premiums of with-profits contracts by a percentage, r% say
Most countries operating this bonus system also offer option of constant premium policies, ie reserves increase by r%, benefits increase by s% (s <=r) and premiums don’t change
In determining r%, it’s common to divide surplus into savings profits (ie investment surplus) and insurance profit (ie surplus from other sources).
Savings profit - profits from assets that can be distributed (in whole or in part) to policyholders
- excess of actual investment return over the expected investment return
- expected return is the valuation interest rate (usually same as pricing basis)
- bonus percentage k will be a significant marketing aspect
- k(i
-i) or (ki-i)
A high proportion of savings profit is usually given to policyholders, with rest retained for shareholders
All insurance profit may go to shareholders or, depending on market, it may be divided between shareholders and policyholders.
Insurance profits - arise from actual experience being better than expected for all sources of profit other than the return on the assets.
State 4 advantages of revalorisation system of surplus distribution
Simple to apply
Codifies exactly how company should declare part of its profits as bonus, so objective (little judgement required) and relatively cheaper to administer
- although judgement needed where policyholders take a share of the insurance profits
Objectivity (codified method) generally protects policyholders from ungenerous life insurers
Takes assets at book value thus includes appropriately smoothed writing-up adjustments/smooth emergence of investment profit is usually achieved
State 4 disadvantages of the revalorisation method of surplus distribution
Company has no discretion in profit distribution (except to extent of spreading of one-off costs, if insurance profits is distributed to policyholders)
Tends to discourage equity investment, as there is no deferral of profit distribution.
- meaning all investment losses would be borne by company and would constitute unacceptable insolvency risk
- also problem regarding treatment of unrealised gains, which are not easy to distribute directly under current revalorisation systems
Versions that do not share insurance profit with policyholders go against principle of mutuality
Difficult to explain to policyholders with constant premiums policies who see very small additions to their guaranteed benefits early in policy term
Describe the contribution system of surplus distribution
Distributable surplus should be distributed among policies in same proportion as those policies are judged to have contributed to surplus.
The dividend given to a particular contract is calculated as:
(V0+P)(i-i) + (q-q)(S-V1) + [E(1+i) - E(1+i)]
1) Interest surplus: excess interest on the (reserve at start of year plus premium paid)
2) Mortality surplus: expected death strain less the actual death strain
3) Expense surplus: excess of expected expenses over actual expenses (accumulated to end of year)
State 2 common variations of the contribution method of surplus distribution
Dividend may be converted into a paid-up addition to benefits, rather than paid out in cash
Terminal dividend may be given - returns to the policholder at maturity part of the difference between the true earned asset share and sum assured
State 3 advantages of the contribution method of surplus distribution
Policyholders receive benefits earlier than under additions to benefits or revalorisation methods
Objective, so more transparent and may appear fairer
Equitable (dividends based on policy’s contribution to surplus)
State 3 disadvantages of the contribution method of surplus distribution
Payment of cash dividend reduces final benefit.
May not be popular if policyholder wishes to pay set premium or is targeting a set benefit for specific purposes
Overall return may be lower, as no deferral of surplus (unless there’s a terminal dividend)
Increased admin of making dividend payments….need to ensure system is set up for the change
Compare the 3 systems of distributing profits (additions to benefits, revalorisation, contribution) with reference to:
- equity and smoothing
- flexibility (discretion)
- simplicity
- investment freedom
Additions to benefits:
- deliberate smoothing of asset share volatility over time.
- Sharing of mortality and expense experience is only very broadly equitable
- maximum flexibility to insurer - how much bonus to give and when
- simple to tell policyholder’s what they are doing, but more difficult to explain/justify (they need to trust the insurer)
- can have a lot if investment freedom (especially if conventional with high TB and super-compoun RB)
Revalorisation:
- equitable distribution of investment profit, mortality and expenses not usually included
- some smoothing over time acheived by valuation method
- no discretion to do anything oter than apply the set formula (depends on accounting environment)
- Simple both to apply and to present
- little investment freedom, as surplus is distributed as it arises
Contribution:
- very equitable w.r.t investment, mortality and expense surplus
- some smoothing
- Considerable fexibility for total amount distributed, but total is split by fairly fixed rules (although some judgement as to groupings for the application of the formula)
- complex to apply and to explain (but maybe easier than UK as it is not reversionary)
- Some investment freedom - some surplus may be held back for termianl dividend but limited by transparency
List 3 reasons why it may be difficult for an insurer to reduce with-profits bonuses to reflect poor experience
Policyholder Reasonable Expectations - makes it ery difficult to refelct poor experience fully in the bonuses they declare
Bonus method e.g revalorisation method usually only distributes investment profits, so any other expense or mortality losses must be born by company
Guarantees mean that there is some level of adverse experience beyond which any further losses cannot be recouped (as cannot declare negative bonuses)
Define PRE (policyholder’s reasonable expectations)
Relates to PRE with regard to level of benefits, or charges, under contracts where these are at discretion of insurer
There is no generally accepted definition of PRE, but they will be influenced, for example, by the past practice of a company and any literature issued by it.
List 3 influences on policyholder’s expectations as regards to the form of the profit distribution and level of bonuses or dividends
given 3 potential consequences of a failure to meet those expectations
Influences on policyholder’s expectations
+documentation issued by insurer
+company’s past practice
+general practice in life insurance market
Possible consequences of failure to meet those expectations
+policyholder dissatisfaction
+risk of losing existing and/or new business
+intervention by insurance supervisory authority in affairs of company (failure to TCF)
State 2 possible benefits of deferring distribution of profits to policyholders.
Give 3 features of an additions to benefits surplus distribution system that could be used to help defer distribution of profits to policyholders
Deferring profit may be
+used to augment company’s free assets and it ability to take on risk
+available to support new business (depending on the regulatory regime)
Using additions benefits system to defer profits distribution
+high proportion of terminal bonus (and lower reversionary)
+conventional with-profits (rather than accumulating with-profits)
+super-compound bonuses (rather than compound or simple)
List 8 possible components of a profit distribution strategy
Amount of each year’s profit distributed (regular bonus) and deferred (terminal bonus)
Split of profit distributed between policyholders and shareholders
Bonus method used
Level of initial guarantees provided
Extent of smoothing of payouts over time
Extent to which profit distributions to individual policyholders reflect actual profit earned by those policyholders
Extent to which policyholders share in profits from other business
Contribution of with-profits business to company’s estate, or vice versa
List 4 aims of profit distribution strategy
To meet PRE regarding payouts and to treat customers fairly
To meet shareholders’ requirements for profit from company’s with-profits business (where appropriate )
To manage capital efficiently/control solvency risk
To control marketing risk
