Chapter 10 - With-profits distribution

Question 1

Describe the revalorisation system of surplus distribution

Answer 1

Bonuses are granted by increasing reserves, benefits and premiums of with-profits contracts by a percentage, r% say

Most countries operating this bonus system also offer option of constant premium policies, ie reserves increase by r%, benefits increase by s% (s <=r) and premiums don’t change

In determining r%, it’s common to divide surplus into
savings profits (ie investment surplus) and
insurance profit (ie surplus from other sources)
A high proportion of savings profit is usually given to policyholders, with rest retained for shareholders

All insurance profit may go to shareholders or, depending on market, it may be divided between shareholders and policyholders

Question 2

State 4 advantages of revalorisation system of surplus distribution

Answer 2

• Simple to apply
• Codifies exactly how company should declare part of its profits as bonus, so objective and relatively cheaper to administer
• Objectivity generally protects policyholders from ungenerous life insurers
• Takes assets at book value
  thus includes appropriately smoothed writing-up adjustments/smooth emergence of investment profit is usually achieved

Question 3

State 4 disadvantages of the revalorisation method of surplus distribution

Answer 3

• Company has no discretion (except to extent of spreading of one-off costs, if insurance profits is distributed to policyholders)
• Tends to discourage equity investment, as there is no deferral of profit distribution.
  meaning all investment losses would be borne by company and would constitute unacceptable insolvency risk
  also problem regarding treatment of unrealised gains, which are not easy to distribute directly under current revalorisation systems
• Versions that do not share insurance profit with policyholders go against principle of mutuality
• Difficult to explain to policyholders with constant premiums policies who see very small additions to their guaranteed benefits early in policy term

Question 3

Describe the contribution system of surplus distribution

Answer 3

Distributable surplus should be distributed among policies in same proportion as those policies are judged to have contributed to surplus

Question 4

State 2 common variations of the contribution method of surplus distribution

Answer 4

• Dividend may be converted into paid-up addition to benefits, rather than paid out in cash
• Terminal dividend may be given

Question 5

State 3 advantages of the contribution method of surplus distribution

Answer 5

• Policyholders receive benefits earlier than under additions to benefits or revalorisation methods
• Objective, so more transparent and may appear fairer
• Equitable (dividends based on policy’s contribution to surplus)

Question 6

State 3 disadvantages of the contribution method of surplus distribution

Answer 6

• Payment of cash dividend reduces final benefit. May not be popular if policyholder wishes to pay set premium or is targeting a set benefit for specific purposes
• Overall return may be lower, as no deferral of surplus (unless there’s a terminal dividend)
• Increased admin of making dividend payments….need to ensure system is set up for the change

Question 7

List 3 reasons why it may be difficult for an insurer to reduce with-profits bonuses to reflect poor experience

Answer 7

• Policyholder Reasonable Expectations
• Bonus method e.g revalorisation method usually only distributes investment profits, so any other expense or mortality losses must be born by company
• Guarantees mean that there is some level of adverse experience beyond which any further losses cannot be recouped (as cannot declare negative bonuses)

Question 8

List

3 influences on policyholder’s expectations as regards the form of the profit distribution and level of bonuses or dividends given

3 potential consequences of a failure to meet those expectations

Answer 8

Influences on policyholder’s expectations
* documentation issued by insurer
* company’s past practice
* general practice in life insurance market

Possible consequences of failure to meet those expectations
* policyholder dissatisfaction
* risk of losing existing and/or new business
* intervention by insurance supervisory authority in affairs of company

Question 9

List 4 aims of profit distribution strategy

Answer 9

• To meet PRE regarding payouts and to treat customers fairly
• To meet shareholders’ requirements for profit from company’s with-profits business (where appropriate)
• To manage capital efficiently/control solvency risk
• To control marketing risk