Ch 38: Surplus and surplus management Flashcards
Define the terms ‘surplus’, ‘surplus arising’ and profit
3
- ‘Surplus’ is the value of the assets less the value of the liabilities.
- ‘Surplus arising’ is the change in the value of the assets less the change in the value of the liabilities over a period of time. Surplus arising is equivalent to profit.
- Profit: Revenue - Expenditure expected over time
Final profit can only be determined once all policies are off-book
List the reasons why providers analyze surplus
DIVERGENCE
- Divergence of actual vs expected (show financial effect / significance of)
- Information to management and for accounts
- Variance as a whole is equal to the sum of the variances from the individual levers.
- Experience monitoring to feedback into ACC
- Reconcile values for successive years
- Group into one-off / recurring sources of capital
- Executive remuneration schemes (data for)
- New business strain (show effects of)
- Check on valuation assumptions and calculations
- Extra check on valuation data and process
Carrying out an analysis of surplus
3
- Involves comparing actual experience with expected
- Expected results are projetced forward so actual values can be compared to them.
- Model used is NB
What are the modelling considerations?
2
- Models used for pricing/profit testing can be used to project income statement an balance sheet variables on a given basis
- Basis used should be realistic and use a consistent set of variables and relationships between variables
How would the expected experience be projected forward?
3
- The projected model output for each model point is scaled up by the expected number of contracts to be sold in each future year.
- Then, for each future year, the number of contracts still in force from the previous years need to be added in.
- This enables expected future revenue accounts and balance sheets for the business to be built up.
How would the model results be compared?
3
3 models need to be used:
* Exp experience with Exp NUB vol
* Exp experience with Actual NUB vol (used to check NUB vol expectation)
* Actual experience with actual NUB vol (compare 1 and 3 for experience)
Explain how the following would be isolated in an analysis of surplus exercise:
- sales volumes not being as expected
- mortality experience not being as expected
For sales volumes, the model described previously can be run a second time, but using the actual volumes of business sold, rather than the expected volumes. A comparison of the results of this model with the results of the first run of the model will show sales volume surplus.
For mortality, the model could be run a third time, this time using the actual number of deaths and actual benefits paid. A comparison of the results of this model with the results of the second run of the model will show mortality surplus.
Outline why it is important for an insurance company to conduct a periodic analysis of surplus
3
- Analysis of surplus is an important part of the ‘monitoring the experience’ stage of the ACC.
- It is necessary in order to provide feedback into the contract design and pricing process.
- Many life insurance contracts are long term and general insurance claims may be long tailed. Waiting until all risks have gone off the books could take years. It is not practical to wait so long to find out whether a contract is profitable or not, since, in the meantime, many more tranches of business will have been written and the insurance company will not want to make the same mistakes.
What are the main sources of surplus to a life insurance company?
4
Demographic factors:
- Mortality / morbidity
- Withdrawals
- New business volumes / new business mix
Economic factors:
- Premiums received
- Expenses, including commission
- Inflation (price and salary)
- Investment income and gains
- Tax
A change in the valuation basis or method used is a further source.
There may also be surplus / deficit arising from events such as counterparty failure or business restructuring.
Define the term ‘levers on surplus’
2
- Levers on surplus are factors that management can use to control the amount of surplus arising.
- Cost of payments and expenses can be controlled by management
Give examples of how claim frequency can be controlled
7
- Monitor claims experience
- Good underwriting of new business
- Good claims management systems
- Eligibility criteria
- Tight policy wording
- Customer incentives not to claim (e.g. no claims discount)
- Policy excesses
Give examples of claim / benefit amounts can be controlled
8
- Monitor claims experience
- Reinsurance
- Good claims management systems
- Provide rehabilitation services (income protection insurance)
- Reduce future benefit payments, e.g. by increasing the age of eligibility or by removing an inflation link.
- Tight policy wording
- Keep guarantees and options to a minimum
- Policy excesses
Give examples of how expense surplus can be controlled
4
- Expense budgeting and monitoring
- Variable charges / premiums
- Ensure that underwriting and claims expenses are commensurate with the size of the claim
- Policy excesses so that small claims (and the associated expenses) are avoided.
Give examples of how a provider can increase the number of contracts that renew or reduce the number that withdraw.
9
- Monitor renewal / withdrawal experience
- Issue renewal notices
- Have automatic renewals
- Maintain competitive premiums
- Offer loyalty discounts
- Provide good customer service and claims handling
- Undertake marketing activities to promote the brand.
- Impose surrender penalties / offer no benefit on surrender
- Claw back commission from brokers on policies that are written.
Give examples of how the provider can reduce the likelihood of an investment return deficit.
8
- Matching (nature, term, currency)
- Subject to this, select investments to maximize overall return
- Diversification by asset class and by stocks within a class.
- Track an index or competitors’ fund allocations
- Select low variance investments
- Tax-efficient investments
- Controls on investment expenses
- Monitor investment experience