Chapter 10 Flashcards
What are the different methods of profit distribution?
- Additions to benefit method - Conventional
- Reversionary
- Terminal
- Additions to benefits - AWP
- Revalorisation method
- Contribution method
How are bonuses granted under the revalorisation approach?
By increasing the reserves, benefits and premiums of WP contracts by a %
* Surplus distributed is expressed as % of supervisory reserves
How should the % increase based on the supervisory reserves be determined?
Divide the surplus into:
* Savings profit - excess of actual investment return over expected investment, multiplied by assets held (r = k(i’-i)). This method uses the end-year reserve as close approximation for amount of assets held during year (Distributed profit = rVt+1)
- Insurance/technical profit - actual experience better than expected, usually distributed to shareholders as a reward for risk taken
To whom is the savings profit mainly distributed?
PHs receive large proportion, and the rest is retained for SHs.
* Depending on market, all insurance profit may go to SHs, or it may be divided between SHs and PHs
Is there a deferral of surplus under the revalorisation approach?
No. Full amount distributed to SHs and PHs as it arises.
True or False? PHs commit to uncertain future increases in premiums under the revalorisation profit distribution method.
TRUE.
True or False? Sums insured under a constant premium contract increase slower than the sum insured under a WP contract distributing surplus according to the revalorisation approach where premiums increase with unknown percentages.
TRUE.
What are the advantages of the revalorisation method?
- Simple to apply
- Formula is known
- Very little judgement required
- Cheap to administer
- Protects PHs from ungenerous ICs
- Method of calculation of asset values leads to smooth emergence of investment profit
What are the disadvantages of the revalorisation method?
- No discretion in surplus distribution
- Tends to discourage equity investment
- Treatment of unrealised gains problematic
- No share of insurance profit is against principle of mutuality
- Not easy to explain to constant premium PHs when revalorised premium policies see much larger increases in benefits
What is the contribution principle under the contribution method?
Each policy receives a share of distributable surplus in proportion to contribution to surplus. Policies should be classified into relatively homogeneous groups.
What is the most common approach for determining each policy’s contribution to the surplus under the contribution method?
The dividend formula.
On what will the actual expense, mortality and interest rates used in the dividend formula be based?
Experience of groups of PHs.
What are the advantages of the contribution method?
- Flexible wrt total distributed surplus
- Amount of distributed surplus determined by company and dividend formula applied with respect to this surplus
- Equitable
What are the disadvantages of the contribution method?
Need to carefully consider how policies should be grouped to share surplus.
What forms can the dividend take?
- Cash payment
- Premium reduction
- Converted to additional benefits
- Terminal dividend
- To align final benefit closer to AS
- May include share of contingency margins
To what is the contribution method closely related?
An AOS on supervisory valuation basis.
What can happen if experience is much worse than expected?
Margins in premiums can be used to compensate IC - depending on PRE
How does a profit distribution to PHs exist?
Premium rates charged contain implicit or explicit margins to generate profit. These margins for profit could equally be looked at as margins against adverse future experience
Why would the ability to use margins in pemiums to compensate the IC against experience being worse than expected vary considerably?
- Revalorisation method only distributes investment profits - any expense or mortality losses must be borne by the company.
- PRE makes it difficult to fully reflect poor experience in bonuses they declare.
- Guarantees mean that there is a level of adverse experience beyond which further losses cannot be recouped.
What is one of a LIC’s most important objectives?
Maximisation of profit distribution to PHs to improve its competitive position - need to balance this with other objectives.
How can a policy’s benefits be improved once it is written?
Maximising bonus distribution.
With regards to what of profit distributions will PHs have expectations?
- Form of the profit distribution
- Level of bonuses
What creates expectations with PHs?
- Documentation issued by the LIC
- Company’s past practice
- General practice in the LI market
What can be the consequences of the LIC failing to meet PRE?
- PH dissatisfaction
- Risk of losing existing and/or NB
- Failure to meet TCFs - in some countries ground for intervention by insurance supervisory authorities
