9: With-profits surplus distribution (1) Flashcards
What are three different approaches to distributing profits on with-profits contracts?
- Additions to benefits approach
- Cash bonus
- Premium reduction
What is meant by ‘surplus’ in the context of with-profits contracts?
Surplus refers to profits generated from with-profits contracts, often exceeding the guaranteed returns.
Name a possible constraint that may prevent a life insurance company from changing its profit distribution approach to benefit increases.
- Legal requirements
- Policyholders’ reasonable expectations
- Competition
- Systems limitations
- Management limitations
- Articles of association
How can delaying profit distribution reduce the probability of insolvency?
By retaining profits, the insurer increases its free assets, enhancing financial stability.
True or False: Delaying profit distribution means that policyholders will receive their bonuses later.
False
What is the fallacy in the argument that delaying profit distribution simply means bonuses are paid later?
The profit is declared and becomes a liability once announced, regardless of when it is paid.
What is a terminal profit distribution?
A lump sum of retained profits paid out at the termination of the policy.
Why might terminal profit distributions be unpopular with policyholders?
They create uncertainty about the amount to be received at the end of the policy term.
What is the assumption behind preferring benefit increases over cash dividends or premium reductions?
It ensures that policyholders ultimately receive adequate benefits when needed.
What type of with-profits policy would be suitable for a policyholder with significant assets but little future income?
A single premium with-profits endowment with annual cash bonus distributions.
What are the main sources of profits in with-profits contracts?
- Excess investment return
- Better-than-expected mortality experience
- Better-than-expected expense experience
What is the ‘additions to benefits’ approach in profit distribution?
Profits are distributed in relation to current benefits payable under each contract.
What are the three kinds of bonuses in the ‘additions to benefits’ method?
- Regular reversionary bonuses
- Special reversionary bonuses
- Terminal bonuses
Define a regular reversionary bonus.
A bonus declared regularly that becomes attached to the basic benefits and is guaranteed.
What are the three methods of calculating regular reversionary bonuses?
- Simple
- Compound
- Super-compound
Which bonus calculation method is more capital efficient?
Super-compound systems are more capital efficient than compound systems, which are more efficient than simple systems.
Under which bonus system would you expect the highest basic sum assured?
Simple bonus system
Under which bonus system would you expect the lowest basic sum assured?
Super-compound system
What is an unusual assumption about level bonus rates throughout a contract’s term?
It would be very unusual unless investment and economic conditions were very stable over time.
Which bonus system is expected to have the highest basic sum assured?
Simple bonus system
Which bonus system is expected to have the lowest basic sum assured?
Super-compound system
What is the relationship between compound bonus and maturity value?
Compound bonus will produce a higher maturity value with a lower initial sum assured.
What is the term used for the expected rates of bonus that are sustained over a contract’s future lifetime?
Bonus earning capacity
What do policyholders expect regarding regular reversionary bonus rates?
They expect them not to vary greatly from one year to another.
What must the declared bonus be in the short term?
Affordable, meaning sufficient profits must have been earned during previous years.
What is a special reversionary bonus?
A one-off increase in benefits granted in addition to regular reversionary bonuses.
What is the advantage of a terminal bonus?
It defers the distribution of surplus until the end of the contract.
When is the amount of a terminal bonus determined?
When the insured event occurs.
What does the terminal bonus aim to equal at the policy maturity date?
The difference between the asset share and benefits guaranteed to date.
True or False: The terminal bonus can be granted on surrender or death.
True
What is the recursive relationship for policy benefit values expressed as?
Ft = Pt - ct + bt
What is the implicit relationship between premium paid and benefits in conventional with-profits contracts called?
Premium Rate
What is the difference between accumulating with-profits and conventional with-profits contracts?
Accumulating with-profits contracts add bonuses annually and have a clear relationship between premiums and benefits.
What does a guaranteed minimum rate of accumulation ensure?
It ensures that the value of the account will not fall.
What distinguishes unitised with-profits contracts from unit-linked contracts?
The company has discretion over the bonuses granted.
What is a market value reduction (MVR)?
An adjustment that may be applied to the surrender value at the company’s discretion.
What happens if a company applies an MVR to an accumulating with-profits fund?
It can adjust the surrender value at its discretion.
What is the purpose of smoothing payouts in with-profits business?
To reduce the impact on the policyholder of fluctuations in investment markets.
What is the bid price of the allocated units less?
Any surrender penalty specified in the contract
What does MVR stand for?
Market Value Reduction
Why might a company apply a market value reduction (MVR)?
To protect against investment selection by policyholders
What is a key difference between unitised with-profits contracts and unit-linked contracts?
Investment return is smoothed in unitised with-profits contracts
What can the benefit on death depend on?
Type of contract (e.g., guaranteed sum assured, return of premiums, return of fund value)
What are the possible premium payment methods?
- Single lump sum
- Recurring lump sums
- Regular monthly or annual amounts
What types of charges may apply to a unit-linked business?
- Policy charge or fee
- Percentage allocation during initial period
- Different percentage allocation after initial period
- Bid-offer spread
- Charge for risk benefits
- Annual management charge
What is the guaranteed death benefit often considered as?
A minimum monetary amount payable on death
What is the formula for calculating the unit fund value after charges?
Unit fund value = Initial fund value - (Total charges)
If a policyholder dies, what is the death benefit calculation based on?
Higher of guaranteed minimum value or unit fund value including terminal bonus
What is the surrender value calculation formula?
Surrender value = (Policy value - MVR - Surrender penalty)
What should a proposed bonus distribution be consistent with?
Policyholders’ reasonable expectations
What does equity in bonus distribution mean?
Fairness in distributing profits among policyholders
How can bonus distribution affect a company’s solvency?
Declaring reversionary bonuses increases guarantees, raising insolvency risk
What is the impact of high reversionary bonus rates on a company?
Restricts free assets and reduces capital for other ventures
How can a company assist future investment strategy with bonus declarations?
By declaring less surplus now as reversionary bonus
What do asset shares represent over time?
Amount available for with-profits policies
Why are asset shares used for determining payouts only on with-profits products?
Benefits for unit-linked and without-profits contracts are determined differently
What does the calculation of asset share help determine?
Rates of terminal bonus
