9. With-profits surplus distribution I

Question 1

Why do we expect surpluses to arise under w/profits business?

Answer 1

• Premiums based on conservative assumptions,
• So company only has to achieve modest experience …
• … to meet guaranteed benefits

Question 2

Ways in which bonuses can be paid

Answer 2

• Increase benefits
• Immediate cash refund
• Reduce premiums payable

Question 3

Key decisions when distributing surplus

Answer 3

• How much it can afford to distribute
• Split of surplus between shareholders and policyholders (may be controlled by legislation, company rules or past practice)
• How surplus will be divided amongst different groups of shareholders

Question 4

Why is profit deferral desirable?

Answer 4

• Reduces insolvency risk
• Increases investment freedom and potential returns

Question 5

Which customers may require increasing benefits to meet their needs

Answer 5

• Those with regular premium savings product with lump sum benefit

Question 6

Which customers may require cash to meet their needs

Answer 6

• Those who are asset rich and income deficient
• For whom single premium structure is suitable
• Reg premium policies with cash bonuses could meet guaranteed monetary liabilities (e.g. loan repayments) at minimum cost

Question 7

Two types of addition to benefits

Answer 7

• Conventional with-profits
• Accumulating with-profits

Question 8

Conventional bonuses can be either

Answer 8

• Reversionary
• Terminal

Question 9

Reversionary bonuses definition

Answer 9

• Declared during policy term and once added are guaranteed

Question 10

4 ways of declaring reversionary bonuses

Answer 10

• Simple
• Compound
• Super-Compound
• Special

Question 11

Simple reversionary bonus

Answer 11

% of basic benefit only

Question 12

Compound reversionary bonus

Answer 12

% of basic benefit plus attaching bonus

Question 13

Super compounded reversionary bonus

Answer 13

Diff percentages of basic benefit and attaching bonus

Question 14

Which reversionary bonus defers profit the most

Answer 14

Super compound&raquo_space; Compound&raquo_space; Simple

Question 15

Special reversionary bonus definition

Answer 15

Once off bonus
- Presented that way to limit expectation of repeats

Question 16

Terminal bonus definition

Answer 16

Paid at claim date but amount isn’t guaranteed

Question 17

Two ways of expressing terminal bonus

Answer 17

• % of attaching bonus only, in which case, % will vary by duration in force and term of contract
• % of basic benefit and attaching bonus, with which % will vary by duration in force

Question 18

Which conventional bonus method defers profit?

Answer 18

Terminal

Question 19

Why are bonuses smoothed?

Answer 19

Protect ph from short-term fluctuation in returns which they’d experience if invested directly into investment markets

Question 20

Accumulating with-profits properties summary

Answer 20

• Operate, superficially, like deposit account.
• Premiums allocated to ph’s account which is
• … increased at a guaranteed rate of acc (may be zero) and by regular discretionary bonuses
• Terminal bonus may be added
• MVR may be applied on surrender
• May be unitised/non-unitised
• Have explicit charging structure like unit-linked contract

Question 21

What does MVR stand for

Answer 21

Market Value Reduction

Question 22

What is an acumulating with-profits contract

Answer 22

Contract where bonuses are added annually in relation to premiums paid to date plus previously declared bonuses.
Terminal bonus may e added when policy becomes claim on maturity, death or surrender.

Question 23

Differences between non-unitised AWP and conventional with-profits contract with single premiums

Answer 23

1. There is an explicit relationship between each premium paid and the increase in benefit to which it gives rise.
2. Guarantees under conventional with-profits likely to be greater than many (but not all) gurantees on awp. (Company my specify min rate of accumulation- now rare)

Question 24

How might regular bonuses be applied on unitised bonus structures?

Answer 24

• Increase units, price of unit unchanged
• Increase price of unit

Question 25

Why do we need MVR on unitised with-profits but not unit-linked ones?

Answer 25

• Investment return is smoothed on a unitised with profits and not directly linked to value of assets&raquo_space;
  » the unit value of a unitised with-profits policy even with a surrender penalty deducted may sometimes be above value of the underlying asset share.
• The company would be vulnerale to surrenders and switches under these circumstances and would be at risk of investment selection by policyholders.

Question 26

Charges on unitised with profits contracts

Answer 26

1. Policy charge
2. Percentage allocation during an initial period
3. Different percentage allocation after initial period
4. Bid-offer spread
5. Risk charge
6. Annual management charge

Alt, charges an be taken implicitly through bonus rate.

Question 27

Similarities between unit-linked and unitised AWP

Answer 27

Premiums:
1. Premiums paid into a unit fund, net of bid-offer spread.
2. In both cases premiums may be reviewable depending on the underlying performance of the assets (and therefore) unit funds.

Charges:
Charges deducted through cancellation of units.

Surrender penalty:
For both product designs there is a surrender penalty.

Question 28

Constant unit price; changing unit price; terminal bonus; surrenders; ch

Differences between unit-linked and unitised AWP

Answer 28

• For unitised accumulating with-profit, one way to handle unit part is for unit price to remain constant and company allocates additional units to each contract, usually annually at bonus declaration
  o For unit linked, unit price changes usually daily
• For unitised acc with profit where unit price changes, change in unit price usually comprises a guaranteed part and a “bonus” part (which is at company’s discretion)
  o For unit linked- change in unit price solely reflects change in net asset value per unit
• For unitised accumulating with profit, may be a terminal bonus
  o Terminal bonuses won’t apply for unit-linked
• For unit-linked; no discretion on surrender value benefit payable, bid value of units less surrender penalty
  o Unitised accumulating may have discretion over right to apply market-value reduction, and size of adjustments to be applied
• For unitised accumulating with-profit, some charges could be taken implicitly through bonus rate, with no explicit charging structure
  o Unit linked will most likely have explicit charges
  and there may be a
  market value reduction for AWP (but not on the unit-linked) to reflect the
  realistic value of the asset share.

Question 29

Bonus distribution considerations

Answer 29

• Be in accordance with PRE
• Satisfy requirements for equity between different groups of policyholders, including different generations
• Not interfere with company’s new business plans, investment strategy or solvency

Question 30

What are the limitations a company may face when trying to change how bonusses are distributed

Answer 30

• Legal requirements
• PRE
• Competitiom
• Systems limitatioms
• Managment limitations
• Articles of association or constitution

Question 31

How is asset share used in bonus distributions?

Answer 31

• Determining terminal bonus rates
• Assessing equity of proposed distribution