9-10 Profit distribution Flashcards
Contribution method - How to calculate the dividend
Investment profit + Mortality profit + Expense profit
the purpose of the formula is to divide the total amount of distributable surplus between the policyholders in as fair a way as possible,
in accordance with the policy’s contribution to the company’s investment, mortality and loading surplus.
In practice, the actual mortality, expense and interest rates used in the dividend formula will be based on the experience of (relatively homogeneous) groups of policyholders.
Contribution method - overview
The “contribution principle”, which underlies this approach, is that distributable surplus should be distributed among policies in the same proportion as those policies are judged to have contributed to surplus.
- Dividend is paid as a cash sum/reduces future premiums or converted into a paid-up addition to benefit
- A terminal dividend may be given, which returns to the policyholder at maturity part of the difference between the true earned asset share and the sum assured.
What are the three methods of bonus distribution?
- Additions to benefits
- Revalorisation
- Contribution
How do the three systems compare, in particular with regard to:
equity and smoothing,
flexibility (ie discretion),
simplicity,
investment freedom?
Policyholder expectations
Policyholders may have expectations as regards the form of the profit distribution and the level of the bonuses or dividends given. Such expectations may be built up from:
- documentation issued by the life insurance company
- the company’s actual past practice
- the general practice in the life insurance market.
Revalorisation method
- Profit/surplus is expressed as a percentage (r%) of the contract’s supervisory reserve.
- The benefit and premium is then increased with that percentage.
- Profit is divided in savings and insurance profit
- Insurance profit retained for distribution to shareholders
- Savings profit = profit from assets = r. V_t+1
- r = i’-i = excess of actual investment return over the expected return
- k = only part of savings profit may be distributed
- k may be guaranteed minimum
- profit distributed may then be k(i’-i) or ki’-i
Revalorisation method
Calculation of i’ and i
Typically, it will be derived from:
- investment income,
- realised gains (or losses), and
- some allowance in respect of unrealised gains (or losses).
The “expected” interest rate is the valuation interest rate. In countries employing this method this is usually the same as the premium basis interest rate.
Revalorisation method
Advantages
- Simple to apply.
- The method codifies exactly how a company should declare part of its profit. Very little judgement is normally required, and should
- therefore be relatively cheap to administer.
- (The exception to this is where policyholders do take a share of the insurance profit: one-off profits or losses (eg due to expenses) are usually spread over a period of time, and judgement might be needed to determine how best this should be done.)
- Protects policyholders from ungenerous life insurance companies.
- By taking assets at book values, including appropriately smoothed writing-up (or writing-down) adjustments, a smooth emergence of investment profit is usually achieved.
Revalorisation method
Disadvantages
- no discretion in its profit distribution (except to the extent of spreading of one-off costs, where applicable)
- The method tends to discourage equity investment. Because the is no deferral of profit distribution
- Versions that do not share insurance profit with policyholders go against the principle of mutuality.
- not easy to explain to policyholders with “constant premium” policies who see very small additions to their guaranteed benefits early in the policy term.
Additions to benefits approach
Accumulating with-profits
- 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.
- looks more like a bank deposit account.
- The individual’s with-profits account starts at zero and is increased (broadly) by the amount of the premiums paid and by bonuses (which are expressed as percentages of the value of the account).
- most common form: Unit With Profits contract
Additions to benefits approach
Accumulating with-profits
Unitised With Profits contract
Overview, benefits, premium, charges, formula
- there is an explicit relationship between each single premium paid and the addition to the benefit to which it gives rise.
- charge could be % of premium or fixed monetary amount, Alternatively, the charges could be taken implicitly through the bonus rate, with no explicit charging structure.
- could have same explicit charging structure as UL
- Death benefit = guaranteed SA, return of premiums, return of fund value
- premium = single lump sum, recurring lump sums, regular monthly or annual amounts
Two ways in which unit part operates:
1. The price of a unit remains constant. Company allocates additional units upon bonus declaration, made up of guaranteed part and bonus part. bonus units are determined at company’s discretion
2. Price of units change on daily basis. increase is made up of guaranteed part and bonus part
Differences between
AWP and conventional WP
- guarantees under conventional with-profits are likely to be greater than many, but not all, guarantees provided by accumulating with-profits products.
- CWP: implicit relationship between each single premium paid and the benefit granted.
- AWP: explicit relationship between each single premium paid and the addition to the benefit to which it gives rise.
- CWP: bonuses declared on SA
- AWP: bonuses declared on current benefit
Differences between
UWP and UL contracts
- There is a difference in the way that the insurer determines the price of the units and therefore the benefits payable.
The key distinction is the discretion that the insurer has over the bonuses granted.
- For unit-linked business there is a direct link to a specified pool of assets, with unit prices being adjusted as and when the underlying asset values change.
- With UWP business bonuses are allocated to the UWP fund at the discretion of the life office.
- For UWP the insurer will take a longer-term view of investment returns and smooth the bonuses it allocates.
Benefits
* For UWP a terminal bonus could be added when the insured event occurs.
* For unit-linked business there is no terminal bonus when the insured event occurs as unit prices change when the underlying asset values change.
Surrender value
* For both products the surrender value will usually be the fund value (possibly less a surrender penalty).
* However, for UWP the insurer may retain the right to apply a market value adjustment (MVA) at its discretion on surrender.
MVR
- needed because the investment return (and therefore the value of units) is smoothed
- rather than linked directly to the value of assets.
- This means that the unit value of a unitised with-profits policy, even with a surrender penalty deducted, may at times be above the value of the underlying asset share.
Additions to benefits
- regular reversionary bonuses
- special reversionary bonuses
- terminal bonuses
- AWP
First three is conventional WP
