Chapter 38 - Surplus and surplus management Flashcards
What are levers, in terms of surplus management?
Factors that can be affected through management control systems to influence the amount of surplus
Define profits, surplus and surplus arising.
Profit = revenue - expenditure
- These amounts are incurred within the time period considered
Surplus = value of assets - value of liabilities
- Normally expected value of liabilities and assets depending on the basis and methodology
- Surplus or deficit will change as the contract’s actual experience unfolds
Surplus arising between T1 and T2 = Surplus @ T2 - Surplus @ T1, T1 < T2
- Surplus arising is equivalent to profit
What is the impact of the choice of basis on surplus arising.
Does not effect the absolute value of surplus arising, which is based solely on actual experience.
Rather influences the timing of when the surplus emerges
Stronger basis -> realise surplus later and deficit earlier in the contract
Weaker basis -> realise surplus earlier and deficit later in the contract
See example on bottom p. 5
Define analysis of surplus (AoS)
Breakdown of the surplus arising over a year into its constituents.
Outline the main reasons for performing AoS
ASSISTING MANAGEMENT DECISIONS
Show financial effect of difference in valuation assumptions and actual experience
Show financial effect of writing new business
- Prudent basis usually leads to new business strain and therefore negative surplus
- Best estimate basis results in much lower/negative initial provisions if business is written on profitable terms, i.e. positive surplus
Identify most financially significant assumptions
Identify recurring and non-recurring elements of surplus to allow appropriate surplus distribution
- E.g. don’t give huge bonus if once-off increase in surplus occurs
Identify trends in experience
- Can feed back into the ACC
Provide management information
PROVIDING INFORMATION
Provide data for use in executive remuneration schemes
Provide detailed published (or other) accounts
DATA AND CALCULATION CHECKS
Validate calculations and assumptions used
Assess data and method used for valuation
Reconcile surplus values for successive years
Demonstrate variance of individual sources of surplus arising provide a complete description of variance in total surplus arising
Outline some of the main considerations when performing an AoS
Essentially trying to identify which assumptions made when valuing premiums, contributions and provisions led to surplus arising
First need to project expected experience
- Build appropriate model
- Project set of expected accounts on some basis
Considerations for the projection model
- Ensure assumptions are consistent with plausible scenarios
- Projection of various revenues and liabilities should interact sensibly, i.e. consistency of basis
- Profit test results (i.e. for single policy) are multiplied by expected number of contracts to be sold for future years
- Persistency and withdrawal assumptions also need to be made for future years
- Once actual experience is observed surplus arising can be broken down into:
> Differences in contract experience (mortality, investment returns etc)
> Differences in sales and persistency experience (volume, withdrawals etc.)
Considerations for expenses
- Need to account for average volume of business in force during the period
- Larger volumes would justify increased expenses
- Therefore need to compare unit costs (expenses/policy) rather than absolute expenditure
List the main sources of surplus/surplus arising
Mortality
Morbidity
Claim frequency
Claim amount
Withdrawals / lapses
Investment income and capital gains
Expenses
Commission
Salary growth
Inflation
Taxation
Premiums / contributions
New business levels
Failure of creditor, such as reinsurer or derivative counter-party
Restructuring of business/fund, e.g. bulk sales or acquisitions
Outline some of the main levers on surplus
REDUCE LIKELIHOOD OF CLAIMS
- Good underwriting of new business
- Good claims underwriting
> Extent of claims underwriting will depend on size of claim and perceived risk of fraud - Customer incentives
> E.g. no claims discount structure of premiums
REDUCING CLAIM COSTS OR BENEFIT AMOUNTS
- Review ongoing claims
> e.g. require proof of incapacity under income protection arrangement - Reinsurance
> Reduce effect of large claims and claims volatility - Reduce future benefit payments
> Should be justified and within terms of contract - Reduce guarantees or stop offering guarantees
- Use of excesses
> Policyholder pays up to excess level before claiming the rest
> Reduce high expenses associated with regular small claims payments, as well as total actual claims
CONTROLLING EXPENSES
- Regularly review expenses
- Flexible charges/premiums
> Can pass on part/all of expenses to policyholder - Ensure claims expenses relate to claim size
> e.g. won’t have expensive claims underwriting process for small claim amount
INCREASING RENEWALS AND REDUCING LAPSES
- Issue renewal notices
- Automatic renewals system
- Loyalty discounts
- Good customer service
- Efficient claims handling
- Marketing activities
- Competitive premiums and bonuses
INCREASE INVESTMENT RETURNS
- Appropriate matching or deliberate mismatching to maximise investment returns within risk appetite
EFFECTIVE TAX MANAGEMENT
- Fully utilise tax advantages and allowances
- Pay tax on time to avoid penalties
- Use tax-efficient vehicles for investment
Briefly outline how surplus is distributed for different types of companies.
Surplus distributed to with-profit policyholders in the form of bonuses
- Form and amount depend on terms of contract, competitive considerations, smoothing decisions etc.
Benefit schemes
- Use surplus to increase benefits or to reduce future contributions (would assume same benefit paid)
Other companies will distribute as dividends or retain to finance capital projects
Outline the key factors which will affect how much surplus a life insurance company distributes.
Also read pp. 19 - 22
Provision of capital
Margins for future adverse experience
Business objectives
Stakeholder expectations
- Policyholders
- Shareholders
- Other, e.g. staff
Outline the main ways a benefit scheme will handle surplus.
Increase benefit values
Reduce future contributions
Transfer all/part of the excess assets back to the sponsor or to the beneficiaries as a once-off benefit payment
Outline the main factors influencing the benefit scheme’s decision of how to handle surplus.
Also read pp. 22 - 25
Legislation
Tax treatment
Scheme rules
Discretion of the sponsor or fund managers
- Some important considerations in this case:
> Risk exposure of various parties should be fairly rewarded when surplus arises
> Source of the surplus
> Industrial relations (i.e. trade unions)
> Speed of corrective action - will depend on relative size of of surplus or deficit
