CH 9 - 10 (Profit Distribution)

Question 1

Ways of Distributing Surplus

Answer 1

• Additions to Benefits
• Immediate cash refund
• Reducing future premiums

Question 2

Types of Additions to Benefits Bonuses

Answer 2

1. CONVENTIONAL
   - Reversionary (during term - attaching to basic benefits)
   > Regular
   » Simple (% of basic benefit)
   » Compound (% of basic benefit + past attached bonuses)
   » Super-compound (two %s: % of basic benefit + % past attached bonuses)
   > Special

• Terminal (at claim date)
  = balancing figure between asset share and benefits already guaranteed
  » % of attaching bonus only
  » % of basic benefit and attaching bonus

2. ACCUMULATING
   - Unitised
   (bonuses paid by increasing unit price or increasing number of units)

• Non-unitised
  (like conventional WP except with explicit relationship between premium and bonuses)

Question 3

Key Decisions on Distribution

Answer 3

1. How much can be distributed
2. Proportion split between shareholders and policyholders
3. Split between different policyholder groups

GOAL:
1. Meeting PRE
2. Meeting shareholder requirements
3. Manage capital efficiency + control solvency risk
4. Control marketing risk

Question 4

Considerations when Distributing

Answer 4

PEALICES

• Policyholder reasonable expectations
• Equity between different policyholder groups and shareholders
  (incl. different generations, categories)
• Asset shares
• Legislation/regulation
• no Interference with new business plans, investment strategy or solvency
• Company rules and strategy/surplus goals
• Established Practice
  (history + competitors)
• Structural limitations
  (guarantees + bonus method limitations)
• SIDES comparison

Question 5

Pros and Cons of Profit Deferral

Answer 5

Appeal to Company:
- Reduce insolvency risk
- Increase investment freedom and potential returns
- Can support new business
- Manage policyholder expectations

Unappealing to policyholders:
- Uncertainty involved
- Marketing risk

Question 6

Definitions of Market Value Adjustment (/Reduction)

Answer 6

-An adjustment made to the benefit payable…
-under an accumulating WP structure,
-to prevent the smoothing mechanism of the bonuses from out-pacing the actual asset share,
-leaving the company vulnerable to selective switches and surrenders

Question 7

Sources of Distributional Surplus

Answer 7

• Investment surplus
• Mortality surplus
• Expense surplus

Question 8

Conventional vs Accumulating WP

Answer 8

Conventional:
> Expressed in “death” or “maturity” value
> No obvious relationship between stated benefit and PV of policy
(doesn’t directly reflect premium contributions to date)

Accumulating:
> Expressed in “current value” (premiums plus related bonuses)
> Looks more like a deposit account
(with profits account starts at zero and is broadly increased by premiums paid and bonuses)
> Reduced guarantees than conventional
(because bonuses are declared on current benefit instead of sum assured; may be guaranteed min rate of accumulations though)
> Terminal bonuses may be added

Question 9

Types of Charging on Unitised

Answer 9

1. Policy charge or fee
2. % Allocation during initial period
3. Bid-offer spread
4. Charge for risk benefits
5. Annual management charge
6. Implicitly through bonus rate reduction

Question 10

Revalorisation Method

Answer 10

• Bonuses granted by increasing reserves, benefits and premiums by %
  > Often option of constant premium policies (reserves increase by r%, benefits increase by s% and premiums don’t change [s<=r] )
• Typically divide surplus into “savings” and “insurance” profits
• Higher proportion of savings profits given to policyholders (insurance profit more to shareholders)

Question 11

Contribution Method Dividends

Answer 11

• Each policy receives share of distributable surplus proportional to contribution

Methods:
1. Paid-out cash sum
2. Converted to addition to benefit
3. Used to reduce future premiums

… terminal dividend may be given

Question 12

Advantages of Revalorisation

Answer 12

SCOPS

• Simple to apply
• relatively Cheap to administer
• more Objective approach to distribution
  (little Judgement required)
• policyholder Protection from ungenerous insurers
• Smooth emergence of investment profit is usually achieved

Question 13

Disadvantages of Revalorisation

Answer 13

MEI DUDE

• without insurance profit being shared to policyholders, goes against principle of Mutuality
• method tends to discourage Equity investment
  (1. Insolvency implications of insurer absorbing the losses and lack of Deferral
  2. issues around Unrealised gains being distributed)
• company has no Discretion in profit distribution
  (besides spreading one-offs)
• not easy to Explain to the policyholders with “constant premium” policies who see limited additions to guaranteed benefits early in policy term

Question 14

Reasons for Retaining Surplus

Answer 14

• Retained for shareholders
• Held against adverse contingencies
• For future distribution as terminal dividends

Question 15

Points of Comparison between Methods

Answer 15

SIDES

• Smoothing
• Investment Freedom
• Discretion/Flexibility (+risks)
• Equity
• Simplicity

Question 16

Define terminal bonus (3)

State 2 ways in which it can be specified for conventional with-profits policies (2)

What kind of profit sources are terminal bonuses usually used to distribute? (1)

What is the general/guiding principle used to determine the level of terminal bonus to distribute? (3)

Answer 16

Terminal Bonus Definition:
> Additional amount payable when insured event occurs.
> Determined when insured event occurs.
> Generally more volatile as company has greater scope to increase if needed.

TB may be specified as:
1. % of total attaching reversionary bonuses possibly varying with duration in force
2. % of total claim amount (basic benefits plus attaching reversionary bonuses) before addition of terminal bonus

Profit source distributed by terminal bonus:
1. Usually used to distribute profits from more volatile sources e.g. capital gains on equity

Usually set as difference between asset share and guaranteed benefits:
1. because aim is to distribute profits to policyholders, allowing for shareholder’s interest and other aspects such as cost of capital.
2. insurer tracks asset shares of sample policies to determine if affordable terminal bonus

Question 17

Unit linked vs Unitised

Answer 17

1. Unit price
   UL:
   Set objectively by direct reference to value of underlying assets
   AWP:
   Set at discretion of company, so only indirect link with value of underlying assets
2. Surrender values equal
   UL:
   Bid price of allocated units
   less any surrender penalty specified in contract.
   Company has no discretion.
   AWP:
   Bid price of allocated units
   plus terminal bonus (if appropriate)
   less any surrender penalty specified in contract
   less any MVR that company may have right to apply

Question 18

Advantages of Contribution Methods

Answer 18

EOE

1. policyholders receive benefits Earlier than under additions to benefits/revalorisation
2. Objective
   (more transparent + may appear more fair)
3. Equitable
   (dividends based on policy’s contribution to surplus)

Question 19

Disadvantages of Contribution Methods

Answer 19

LARD

1. no Deferral of surplus may result in overall Lower return
2. increased Admin of paying dividends
   (incl cost of system change)
3. payment of cash dividend Reduces final benefit which might not be popular
   (p/holder may want set premium or specific benefit)

Question 20

Getting greatest deferral of surplus distribution

Answer 20

1. Additions to benefits
2. High proportion terminal bonus
3. Conventional WP instead of Accumulating WP
4. Super compound
   (instead of compound or simple)