38. Surplus and surplus arising Flashcards
What is surplus?
V(A)-V(L)= Surplus
What is surplus arising?
- Change in V(A) - Change in V(L) over a period of time= Surplus arising
- Equivalent to profit
- Often referred to as ‘Surplus’
Why do providers analyse surplus?
DIVERGENCE
- Divergence of actual vs expected
- Information to management and for accounts
- Variance as a whole= sum of variance individual levers
- Experience monitoring=> Feedback into ACC
- Reconcile values for successive years
- Group into one-off/recurring sources of surplus
- Executive renumeration scheme (Data for)
- New business strain (show effects of)
- Check on valuation assumptions and calcs
- Extra check on valuation data and process
What does an analysis of surplus involve?
- Comparing what actually happened
- To what was expected to happen
Carrying out an ‘analysis of surplus’ involves comparing what actually happened over the year with what wa expected to happen:
How would E[experience] be projected forward?
- Use a model capable of projecting: IS and BS on the expected experience basis
- Such a model usually already exists e.g. Original pricing model or profit testing model
- Model must be self-consistent i.e. Assumptions+ diff elements of output=> are mutually consistent
- Projected model output for each model point=> scaled up E[# Future Contracts] for each year
- For each future year # of Contracts still in force from previous years are added in
- Enables E[IS] and E[BS] to be built up
How would sales volume not being as expected be isolated in an analysis of surplus exercise?
- Model previously described
- Run 2nd time
- With the actual sale volumes rather than expected volumes
- Compare the two=> Sales volume surplus
How would mortality experience not being as expected be isolated in an analysis of surplus exercise
- Run the previous model again
- Using actual # of deaths and actual benefits paid
- Compare this and sales run model=> Mortality surplus
Why is it important for an insurance company to conduct a periodic analysis of surplus?
- Important part of monitoring experience=> ACC
- Provide feedback=> contract design and pricing process
- Life insurance companies=> long term
- General Insurance=> Long tailed
- Wait until risks have gone off the books=> TOO LONG
- Prevent making same unprofitable mistakes in future tranches of business
What are the main sources of surplus to a life insurance company?
Demographic factors
- Mortality/morbidity
- Withdrawals
- New business volumes/ new business mix
Economic factors
- Premiums received
- Expenses inc commission
- Inflation (price and salary)
- Investment income+ gains
- Tax
- Change in the valuation basis
- Surplus or deficit from counterparty failure+ business restructuring
How can claim frequency be controlled through management actions?
- Monitor claims experience
- Good underwriting of new business
- Good claims management system
- Eligibility criteria
- Tight policy wording
- Customer incentives not to claim (e.g. NCD systems)
- Policy excesses
How can claim/benefit amounts be controlled?
- Monitor claims experience
- Reinsurance
- Good claims management system
- Provide rehabilitation services (Income protection insurance)
- Reduce future benefit payments (e.g. inc elligibility age, remove inflation link)
- Tight policy wording
- Keep guarantees and options to a minimum
- Policy excesses
How can expense surplus be controlled?
- Expense budgeting and monitoring
- Variable charges/premiums
- Ensure underwriting and claims expenses are commensurate with the size of claim
- Policy excesses so that small claims and associated expenses are avoided
How can a provider increase the number of contracts that renew and reduce withdrawal rates?
- Monitor renewal/ withdrawal expense
- Issue renewal notice
- Have automatic renewals
- Maintain competitive premiums
- Offer loyalty discounts
- Provide good customer service and claims handling
- Undertake marketing activities to promote brand
- Offer surrender penalties/ or no benefit on surrender
- Claw back commission from brokers on policies that have withdrawn
How can a provider reduce the likelihood of investment return deficit?
- Matching (term, nature and currency)
- After matching=> select assets to max returns
- Diversify by asset class and individual assets in the class
- Track and index or competitors fund allocation
- Select low variance investments
- Tax-efficient investments
- Controls on investment expenses
- Monitor investment experience
How can a provider adopt a good/effective tax management policy?
- Utilise tax allowances fully
- Use tax-efficient investments
- Pay tax on time to avoid penalties
What issues affect the amount of surplus a life insurance company should distribute?
Constitution of the company
- Mutual=> 100% policyholders
- Proprietary=> shareholders + policyholders (If with profit) or 100% to SH (if without profit)
Provision of Cap
- deferring distribution of surplus=> is source of Cap
- Depends on the form of distribution
Margins for adverse experience
- Pace of distribution of surplus is unlikely to match pace at which profits arise
- Sustained overdistribution drains free assets
- Sustained under-distribution will not meet policy holder expectations
Business objectives
- Maximise distribution to improve competitive position and generate business VS
- Maintain surplus (Cushion against risk, writing NB, investment freedom)
Stakeholder expectations (SH and PH)
- Failure to meet can lead to:
- Loss of business
- Supervisory intervention
List the uses of surplus in a benefit scheme
4
- Enhance benefits
- Reduce contributions
- Return to the sponsor (not always allowed)
- Retain as a cushion against adverse experience
- NB once enhanced benefits cannot be reduced or removed
What considerations should be taken into account when deciding how, when and to whom a DB pension will distribute positive surplus?
8
- Legislation=> Dictates categories of members should have priority for distribution of surplus
- Tax=> surplus funds may be excluded from beneficial tax treatment
- Scheme rules=> restrictions on the distribution of surplus avoid potential disputes
- Discretion of the sponsor or scheme manager (in absense of 1 and 3)
- Risk=>e.g. if sponsor makes right any deficit, it may feel it should receive surplus
- The source of surplus => does it belong to certain mebers?
- Preserving industrial relations with memebrs and other employees
- Speed of corrective action => distribution of surplus may be lower pace
