21 Surplus Distribution

Question 1

Describe/compare the types of bonus:
- Regular reversionary
- Special reversionary
- Terminal
(6)

Answer 1

RB:

• Sets PRE of maintenance of bonus rates.
• Impacts free assets or own funds if actual bonus rates differ from those used in the valuation basis.

SB:

• Lower PRE effect so less of a constraint.
• More likely to impact free assets or own fund as less likely to have been included in the TPs.

TB:

• Lower levels of guarantees and greater volatility of payouts compared to RB/SB.
• Results in more free assets / own funds so allows greater investment freedom.

Question 2

Describe the general suitability of different sources of surplus for distribution as different types of bonus. (3)

Answer 2

1. Surpluses that expected to arise regularly (e.g. from explicit bonus loadings in premiums) would be suitable for RB.
2. Surplus that is expected only in one-off occasions is most suitable for SB.
3. Surpluses that are less regular or predictable are suitable for TB.

Question 3

List seven factors that will influence the timing of surplus distribution. (7)

Answer 3

1. The company’s financial aims (e.g. to maximise returns to policyholders).
2. Level of guarantees.
3. Free Assets / Own Funds.
4. Investment Strategy / Freedom.
5. Achieving Equity.
6. TCF / PRE.
7. Shareholder transfers.

Question 4

State two types of bonus rate smoothing. (2)

Answer 4

1. Over time.
2. Between groups of policyholders.

Question 5

List five factors that affect the degree of smoothing. (5)

Answer 5

1. TCF
2. The method of distributing surplus.
3. The assets backing the contracts.
4. Free Assets / Own Funds.
5. Company policy (set out in the PPFM).

Question 6

List four investigations a company would perform in making its bonus decisions. (4)

Answer 6

1. Relevant experience investigations (in order to determine asset shares).
2. Bonus supportability (especially of RB rates).
3. Bonus equity (especially of TB rates).
4. ALM to assess future solvency.

Question 7

Describe the method of determining a set of bonus rates and list the factors to be considered.

Answer 7

1. Carry out a Gross Premium Valuation on realistic assumptions, incorporating the current rates of RB and making an assumption on TB rates to be awarded.
2. Choose specimen contracts that model the existing WP business.
3. For each specimen contract, compare the gross premium reserve with the earned asset share.
4. Significantly different results for different classes may lead to different series of bonus rates being delayed.
5. Factors to consider are: TCF, PRE, past practice, policyholder communications and PPFM.
6. Also check rates can support expected NB and are supportable under various scenarios.