Chapter 38

Question 1

1. What is the difference between profit and surplus and surplus arising

Answer 1

Profit = revenue – expenditure
Profit cannot be determined until all risks have gone off the books (this means the profit before this needs to be estimated)
Surplus = total free assets = value of assets – value of liabilities
This is highly dependent on the valuation basis (the more prudent it is, the lower surplus will be)
Unlike profits, this is retained
Surplus arising=(A(t+1)-L(t+1) ) - (A(t)-L(t))
Change in surplus over a period of time
Appears in both the statement of profit or loss (make allowances for establishing provisions) and balance sheet (make allowances for the change in asset values)

Question 2

2. Where does surplus arising stems from?

Answer 2

• Usually comes from better than expected investment returns - increases
• lower than expected benefit payments - increases
• releasing provisions - decreases
• establishing provisions (decreases)

Question 3

3. reasons for performing an analysis of surplus (AoS)

Answer 3

• Assisting in management decision making
  a. Divergence of valuation assumptions and actual experience
  b. which assumptions are the most significant
  c. financial impact of writing new business
  d. distribution of surplus (helps identify non-recurring components of surplus)
  e. provides management information
  f. gives information on trends which feeds back to the actuarial control cycle
• Gives information for other purposes
  g. executive remuneration schemes
  h. accounts
• data and calculation checks
  i. validation of calculations/ assumptions
  j. independent data checks
  k. reconciliation over periods
  l. completeness of description

Question 4

4. How is an AoS carried out?

Answer 4

• Formula approach
• Gives approximation
• Assumes deaths occur midway through the year
• Rerun approach
• Surplus(t) = Net Asset(t) – Reserves(t)
• Change factor F1 and recalculate Net Asset – Reserves = SF1
• Surplus arising F1 = SF1 – Surplus(0)
• Factor 1 is now in actual level
• Change F2 from expected to actual and recalculate Net Asset – Reserves = SF2
• Surplus arising F2 = SF2 – SF1

Question 5

5. What are the sources of Surplus? (16)

Answer 5

• Mortality
• Morbidity
• Claim frequency
• Claim amounts
• Withdrawal/Lapses
• Investment income and gains
• Expenses
• Commission
• Salary growth
• Inflation
• Taxation
• Premiums/contributions paid
• New business levels
• Failure of reinsurer
• Restructuring of business (acquisition)
• Change of valuation methods or assumptions

Question 6

Issues surrounding the amount of surplus to distribute

Answer 6

Life insurance company
* provisions of capital and margins for future adverse experience
- with profit policies have high premium rates as these include margins designed to generate profit that will be distributed to policyholders
* margins for future adverse experience
* business objectives of the company
* policyholder, shareholder and other stakeholder (including staff) expectations

Benefit Scheme
* legislation – likely to be the major factor
* scheme rules
* tax treatment
* discretion of the sponsor/managers

Sponsor or managers
* risk exposure of the various parties
* source of the surplus or deficit
* expected effect of that decision on industrial relations

Question 7

Levers on Surplus/profit

Answer 7

• reduce the likelihood of claims (claims frequency):
  -Good underwriting of new business
  -Good claims assessment and management
  -Incentives not to claim
• reduce the cost of claims (claims severity)
  -Claim review
  -Reinsurance
  -Use of excesses, copayments and limits
  -Reducing future benefits
  -Minimise guarantees (with-profit)

-Controlling Expenses
-Increasing investment return
-Effective tax management
-increase renewals and reduce lapses

Question 8

Distribution of any surplus/profit arising

Answer 8

• for life insurance companies with with-profit policyholders:
• some (if some, then the surplus will be retained as working capital or given to shareholders)
• for other corporate institutions (life insurers with (unit-linked, without profit) policyholders, general insurers, banks), the surplus belongs to shareholders and is either:
• retained in the business
• distributed as dividends
• benefit schemes any surplus is usually retained within the scheme, and may be used to:
• enhance the benefits of members
• reduce future contributions of members and the employer (first option as this can be changed while enhancing the benefit can’t)
• It may or may not be possible to return surplus to the sponsor hence first choice is to reduce contributions