C37 : Surplus and Surplus management Flashcards
Outline why a provider of financial product need to assess the profit arising on a regular basis
- Because of the long-term nature of financial services contracts, the final profit from a scheme or tranche of policies cannot be determined until all have gone off the books.
- Waiting until this happens before the terms under which the next tranche of policies are written can be determined is clearly impractical
- To monitor the progress of the business it is necessary to value the outstanding liabilities from time to time, often annually.
- the amount of surplus can be estimated by valuing the assets and liabilities on a chosen set of
assumptions.
Describe possible actions the insurance company could take, if contract is not profitable
- Improve profitability : reduce expenses, improve underwriting,
- Reprice the product
- stop selling the business or change its profit criterion
Why a provider will want to analyse the change in any surplus arising over a year or a longer period of time
Provider will want to analyse the change in any surplus arising over a year or a longer period of time to:
- assisting the management in decision making
– financial effect of divergences
– financially significant assumptions
– effect of writing new business
– distribution of surplus
– management information
– information on trends - providing information for other purposes
– executive remuneration schemes
– accounts - data and calculation checks
– validation of calculations / assumptions
– independent data check, reconciliation over periods
– completeness of description.
List sources of surplus / deficit
Possible sources of such surplus / profit (deficit / loss) include:
mortality
morbidity
withdrawal / lapses
investment income and gains
expenses
salary growth
inflation
claim frequency
claim amounts
commission
taxation
premiums / contributions paid
new business levels.
Two sources of surplus/deficit that can arise as a results of a strategic event
Sources of surplus (or deficit) can arise as a result of more strategic events, such as:
1. failure of reinsurer or of derivative counterparty
2. Restructuring of the business / fund, such as bulk sales or acquisitions.
Define ‘Levers on surplus’
The levers that can control the amount of surplus / profit are the factors that the provider can affect by using management controls to increase value.
Give examples of levers on surplus
Management can try to:
- Reduce the likelihood of claims through:
– good underwriting of new business
– good underwriting at the claim stage
– providing customer incentives not to claim - Reduce the cost of claims through:
– cost-effective claims management procedures e.g. by periodically reviewing ongoing claims
– using reinsurance to limit the volatility of claims or to protect from the risk of large claims
– reducing future benefit payments
– keeping guaranteed benefits to a minimum
– introducing / increasing excesses - control expenses:
– periodically reviewing expenses
– keeping charges / premiums flexible
– ensuring that claims expenses are commensurate with the claim size - Reduce the number of contracts that lapse or that do not renew at the renewal date
- Follow an investment policy that increases
investment returns (subject to an acceptable level of risk) - Adopt an effective tax management policy.
Suggest ways in which an insurance company might ensure that new business is adequately underwritten.
It could ensure that:
the level of risk is taken into account at the new business stage by requesting pertinent data such as previous claim history, convictions etc.
unacceptably high risks are defined and excluded
policy documentation is watertight, e.g. exclusions are given and worded carefully
data is shared with other insurers regarding individuals who have made fraudulent claims in the past.
Give examples of measures to prevent fraudulent claims.
Give examples of good claim underwriting
Underwriting at the claim stage (or loss-adjusting) can help both to reduce excessive claims and to identify fraudulent claims.
A provider can put measures in place to prevent fraudulent claims. The requirement to see
medical certificates
death certificates
reports by loss assessors
pictures of damage
pictures of stolen goods
evidence of business continuity incidents
Two factors affect the extent of success/level of claim underwriting
Level of claim underwriting depends on
1. size of the loss / claim
2. perceived risk of fraud.
E.g.
1. life insurance company in a developed country may require more evidence than just a death certificate in the case of a death on holiday in an undeveloped country for a young life with a high sum assured, where the policy was recently taken out.
- For general insurer, loss by theft is particularly susceptible to fraud, because by its nature the items stolen are not available to view after the theft. Policyholders should be advised to have photographs of any small, high value items, such as jewelry.
Ways to control frequency of claim
- Monitoring claims experience
- Good underwriting of new business
- Good claims management systems
- Eligibility criteria
- Tight policy wording
- Providing customer incentives not to claim e.g. excesses, NCD
Ways to reduce claim/benefit amounts
- Monitoring claims experience
- Reinsurance
- Good claims management systems
- Reducing future benefit payments e.g. increasing age of eligibility, removing inflation link
- Tight policy wording
- Keeping guarantees and options to a minimum
- Policy excesses
Ways to control expenses
- Expense budgeting and monitoring
- Variable charges/premiums
- Outsourcing
- Ensuring that underwriting and claims expenses are commensurate with the size of the claim
- Policy excesses so that small claims (and associated expenses) are avoided
Ways to Increase Renewals
- Issue renewal notices
- Automatic renewals
- Maintain competitive premiums
- Loyalty discounts
- Good customer service and claims handling
- Marketing activities to promote the brand
Ways to reduce lapses/withdrawal
- Monitoring of withdrawal experience
- Surrender penalties
- No surrender benefit
- Commission claw back from brokers on policies that are withdrawn
- Maintain competitive premiums
- Ensure good customer service standards
- Loyalty bonuses
Ways to Increase investment returns
- Select investments that are appropriate to the nature, term and currency of the liabilities, and the provider’s appetite for risk
- Select investments to maximize the overall
return on the assets, where overall return includes both income and capital.
Ways to ensure effective tam management
- Utilise tax allowances fully
- Hold tax-efficient investments
- Pay tax on time to avoid penalties
- Look for ways of offsetting tax paid e.g. expenses against investment returns
Issues in distributing life insurance surplus
- Constitution of the company – mutual => 100% to policyholder, proprietary => split between shareholders and policyholders (if with-profits) or 100% to shareholders (if not with-profits)
- Provision of capital – deferring the distribution of surplus is a source of capital. Whether deferral is possible depends on the form of distribution (Reg/Ter)
- Margins for adverse experience – pace of distribution is unlikely to match pace at which profit arises. Sustained over-distribution drains free assets; sustained under-distribution may not meet policyholders’ expectations
- Business objectives – maximising distributions to improve competitive position (and generate business) vs maintaining surplus (as a cushion against risk, for writing NB and investment freedom)
- Policyholders’ expectations – failure to meet these issues may lead to loss of supervisory intervention
Uses of surplus in a benefit scheme
- Enhance benefits
- Reduce contributions of EE/ER
- Return to sponsor (not always allowed)
- Retain as a cushion against adverse experience
(Note benefits cannot be removed or reduced once enhanced, so reducing conts may be first choice)
Considerations when a DB pension distributes surplus
- Legislation - whether this dictates which categories of members should have priority for the distribution of surplus
- Tax - since surplus funds may be excluded from beneficial tax treatment
- Scheme Rules – which may deliberately have placed restrictions on the use of surplus to avoid potential disputes should it arise
- Discretion of sponsor (in absence of restrictions from (1) to (3)
- Risk – if sponsor bears the risk of making good any deficit, it may be felt that the sponsor should benefit from any surplus
- Source of the surplus – if the surplus is from a volatile source it may be appropriate to retain it as a balance for future volatility
- Pace of the distribution of surplus – which is often slower than the correction of a deficit
- Preserving industrial relations with members and employees
- Whether the employee contributes to the scheme or not
