Chapter 10: With-profits surplus distribution (2)

Question 1

Revalorisation method

Answer 1

The profit, or surplus, to be given to a particular contract is expressed as a percentage, r% say, of the contract’s supervisory reserve.

The benefit under the contract and the premium payable by the policyholder are then increased by the amount.

Question 2

Contribution method dividends

Answer 2

The contribution principle is that each policy receives a share of distributable surplus in proportion to its contribution to surplus.

Question 3

Policyholder expectations are built up from: (3)

Answer 3

1. documentation issued by the life insurance company
2. the company’s actual past practice, and
3. the current practice in the life insurance market.

Question 4

Savings profit:

Answer 4

The “savings” profit represents the profit from the assets and can be distributed, in whole or in part, by the “revalorisation” method.

Question 5

Insurance profit:

Answer 5

The “insurance” profit is that arising from actual experience being better than expected for all sources of profit other than the return on the assets.

Question 6

Advantages of the revalorisation method: (4)

Answer 6

1. It is simple to apply
2. The method codifies exactly how a company should declare part of its profits as bonus to WP policyholders. Very little judgment is normally required and should therefore be relatively cheap to administer.
3. Having a codified method generally protects policyholders from ungenerous life insurance companies.
4. By taking assets at book values, including appropriately smoothed writing-up (or writing-down) adjustments, a smooth emergence of investment profit is usually achieved.

Question 7

Disadvantages of the revalorisation method: (4)

Answer 7

1. The company has no discretion in its profit distribution
2. The method tends to discourage equity investment. This is because of the fact that there is no deferral of profit distribution. This means that all investment losses would be borne by the company and would constitute an unacceptable insolvency risk.
3. Versions that do not share insurance profit with policyholders go against the principle of mutuality.
4. It is not very easy to explain to policyholders with “constant premium” policies who see very small additions to their guaranteed benefits early in the policy term.

Question 8

The advantage of bonus deferral:

Answer 8

• If the surplus distribution method permits deferral of bonus, such deferral may increase the company’s free assets.
• Any “extra” free assets can, until needed for policyholder benefits, be used to increase investment freedom and to finance new business.

Question 9

Determining the bonuses under contributions method: (4)

Answer 9

1. The insurer will sub-divide the book of with-profits policies into homogeneous group with similar features.
2. It will then assess the actual experience of each group of policies and compare that to the expected experience.
3. This will identify what the sources of surplus were for each group of policies, and allow the insurer to attribute mortality, investment and expense profits directly to the groups of policies on which they arise.
4. In determining a final dividend for each group of policies, the insurer may decide to retain some profit for smoothing purposes or to improve the solvency position.
5. The cash dividend will then be distributed separately to each group of policies according to the following formula:

Cash dividend = (V0 + P)(i’’ - i) + (q - q’)(S - V1) + E(1+i) - E’‘(1 + i’’)