Chapter 9: With-profits surplus distribution (1)

Question 1

Three ways that profit can be distributed: (3)

Answer 1

1. cash bonus
2. premium reduction
3. benefit increase

Question 2

The key decisions for the company (w.r.t surplus) are: (3)

Answer 2

1. how much surplus it can afford to distribute
2. if it has shareholders, how it will split surplus between shareholders and policyholders.
3. how it will divide surplus between different groups of policyholders.

Question 3

Profit deferral

Answer 3

For the insurer it is desirable to defer the distribution of surplus. This reduces insolvency risk, and also increases investment freedom and potential returns.

Question 4

Regular reversionary bonuses

Answer 4

• A regular reversionary bonus is a reversionary bonus that is declared on a regular basis, usually each year, through out the lifetime of the contract.
• Once declared it becomes attached to the basic benefits and is guaranteed i.e. it cannot be taken away.

Question 5

Terminal bonus

Answer 5

A terminal bonus may be paid at the claim date but its amount is not guaranteed.

Question 6

The amount of the reversionary bonus can be calculated in one of the 3 ways:

Answer 6

1. Simple - as a percentage of basic benefit only
2. Compound - as a percentage of basic benefit plus attaching bonus
3. Super-compound - different percentages of basic benefit and attaching bonus. Where this method is used the attaching bonus percentage is typically higher than the first.

Question 7

Terminal bonus may be expressed as: (2)

Answer 7

1. a percentage of attaching bonus only, in which case the percentage may vary by duration in force and original term of contract
2. a percentage of basic benefit and attaching bonus, with the percentage varying by duration in force.

Question 8

Name an alternative to conventional with-profits

Answer 8

Accumulating with-profits

Question 9

Forms of Accumulating with-profits contracts

Answer 9

Accumulating with-profits contracts may come in unitised or non-unitised form, and in either case may have an explicit charging structure like that of a unit-linked contract.

Question 10

How Accumulating with-profits operate (3)

Answer 10

1. They operate, superficially, rather like a deposit account, with premiums being allocated to a policyholder’s account, which is then increased at a guaranteed rate of accumulation and by regular discretionary bonuses.
2. A terminal bonus may be applied at maturity, death or surrender.
3. A market value reduction (MVR) may be applied on surrender.

Question 11

Bonus distributions should: (3)

Answer 11

1. be in accord with policyholders’ reasonable expectations
2. satisfy the requirements for equity between different groups of policyholders, including the different generations
3. not interfere with the company’s new business plans, investment strategy or solvency.

Question 12

Use of the asset share

Answer 12

The asset share is particularly important for helping to determine terminal bonus rates and in assessing the equity of any proposed bonus distribution.

Question 13

Why might the benefit increase option be preferred compared to a cash bonus:

Answer 13

• Assuming that the policyholder has an eventual use for the ultimate policy benefits,
• it may be considered unfortunate to put policyholders in a position of receiving cash, or premium reductions, only later to find that the future bonuses are reduced and the ultimate policy benefits are insufficient for the policyholder’s needs.

Question 14

The bonus earning capacity:

Answer 14

The bonus earning capacity of a block of contracts is the rate - or rates - of bonus that those contracts can sustain over their future lifetime, on the basis of a set of assumptions with regard to future experience.

Question 15

Accumulating with-profits:

Answer 15

• An accumulating with-profits contract is a with-profits policy to which bonuses are added annually in relation to the premiums payable to date plus previously declared bonuses.
• A terminal bonus may be added when the policy becomes a claim on maturity, death or surrender.

Question 16

There are two basic ways in which the unit part of a unitised with-profit contract could operate:

Answer 16

1. The price of a unit remains constant. The company allocates additional units to each contract, usually annually at the bonus declaration.
2. The company, instead of allocating additional units, changes the price of a unit, usually on a daily basis.

Question 17

The charging structure (for with-profits) may be as for unit-linked business i.e. any combination of: (6)

Answer 17

1. policy charge
2. percentage allocation during initial period
3. a different percentage allocation after the initial period.
4. bid-offer spread
5. charge for risk benefits
6. annual management charge
   - Alternatively, the charges could be taken implicitly through the bonus rate, with no explicit charging structure.