Chapter 12-Surplus-An Insurance Company's Capital Flashcards
What are some characteristics of the capital and surplus?
- Needed to absorb unexpected fluctuations in death claims
- Needed since life companies may not adjust premiums
- Each state have minimum capital requirements that all life companies must meet
- NAIC’s new capital standards are based on both mortality and investment risk
What are some characteristics of the immunizing process that some life companies use?
- Interest risk immunization can be achieved by arranging the value of assets and liabilities to move in the same direction and at the same pace in response to rate changes
- Investment portfolio immunization can be achieved by owning bonds whose market value increase when variable rate mortgage income declines due to market rates
What are some characteristics of duration matching of assets and liabilities by a life company?
- Asset duration is the average length of the assets holding period
- Liability duration is the average time period from policy issuance until claim payment
- Duration matching means matching liability duration with asset duration
- Duration matching is really cash flow matching
What are some characteristics of the supply of capital for a life company?
- The need for capital varies directly with the company’s rate of growth (the cost of a new policy exceeds the initial premium collected)
- Primary source of capital for a life company is internal (from favorable mortality, investments, and expenses)
What are some characteristics of of life companies operating results in the 1990’s?
Profits of life companies were reduced due to increased death rates from AIDS and declining market interest rates
(solvency was not threatened)
What are some characteristics of accessing capital as a life company wishing to expand new business sales?
- Issuing bonds and selling real estate to an insurer sponsored REIT can increase capital
- A mutual company can demutualize
(from a finance perspective, purchasing reinsurance is the borrowing of the use of the reinsurer’s capital)
What are some characteristics of the need for and use of a life company’s surplus?
- Financing new business growth is a typical young life company’s most significant demand for capital
- If a stock company increases dividends on its participating policies, they become more competitive
- A liberal stockholder dividend policy may impair the company’s contingency fund
(some stockholders may prefer surplus retention over dividends that would be taxed since heirs may receive the increased value tax free)
What are some guiding principles in the distribution of divisible surplus?
- Simplicity (Favorable public relations/understanding of the dividend process and rationale is an important objective)
- Equity (divisible surplus should be allocated among the group of policyowners by proportion that each group contributed to surplus)
- Flexibility (to be equitable, the distribution system should be responsive to changing conditions that affect the sources of divisible surplus)
- Comprehensibility (is a minor consideration that involves insuring that the public understands the policy dividends)
(reducing dividends would be bad public relations)
(accessing previous years surplus is an option during a period of adverse experiences)
What are some characteristics of maintaining a life company’s current dividend scale?
- As a minimum, life companies prefer to continue their dividend scale
- When favorable experiences create an addition to surplus that is more than adequate for the current dividend, life companies often add the excess to their balance sheet surplus
- For most companies, maintaining their current dividend scale means a larger absolute distribution than in the preceding year (due to more policies being on the books)
What are some characteristics of dividend payments or extra dividends by a life company?
- The two options are single payment and periodic payment
- Most states require an annual apportionment or distribution of a company’s divisible surplus
- The single extra dividend is typically a substitute for a first year dividend
- Periodic extra dividends can be justified due to the conservative dividend policy of so many life companies that additional surplus remains even after payment of annual dividends
- Withholding an extra dividend payment for multiple years assesses a larger part of the excess first year expenses against the policies that are terminated in that period of time (early terminating policy owners do not receive the extra dividend so their cost of coverage is higher by the amount of extra dividend that they never received)
What are some characteristics of of terminal or surrender dividends?
- Paid when a policy is terminated by death, surrender, or maturity
- Usually available only if the policy has been in force for a minimum period of time
- Terminal dividend paid during surrender is usually a percentage of the policy’s surrender value
- The rationale that terminal dividends emphasize that a withdrawing policy owner should receive at least a portion of their contribution to the company’s surplus
- The Standard Nonforfeiture Law requires that payment of the surrender dividend to the policy owner if the rate of interest use to determine reserves is more than 0.5% less than the rate used to calculate the policy surrender values
(majority of U.S. life companies do not pay a surrender dividend)
(postmortem dividends are different and are paid in addition to terminal dividends)
What are some characteristics of determining policy owner dividends?
- After several years, mortality contribution to the dividend for an ordinary life policy is the tabular cost of insurance minus the actual mortality charge
- After several years, the interest rate contribution to the dividend for an ordinary life policy is the policy’s initial reserve, plus the policy’s net level premium, multiplied by the difference between the assumed rate of interest and the policy’s ”dividend rate of interest”
- Actual mortality charge is the ratio of the company’s actual mortality over tabular or expected mortality for the policy owners attained age, multiplied by the tabular cost of insurance
- If there is no change in the rate of investment return, the interest contribution to a policy’s dividend should increase over time due to the increasing amount of the policy’s initial reserve
What are some characteristics of of a life company trying to achieve general equity in their dividend scales?
- Under provisions of a three factor contribution plan, factors affecting dividend are mortality savings, excess interest, and loading savings
- All policy owners receive dividends base on identical scales, those who do not borrow subsidize those who do
- Direct recognition dividend scales attempt to increase equity of dividend distributions
- The use of direct recognition dividend scales is an attempt to increase equity of dividend distributions
(Computer use will not increase the factors used to create a divisible surplus because it would unnecessarily complicate the dividend formula)
What are some characteristics of the divisible surplus concept of life companies?
- A life policy asset share should be greater than the amount of the policy reserve
- Most companies plan to have the contingency reserve increase as the policy owner’s reserve increases
- Equity demands that each block of policies contribute a share of the company’s contingency reserve
- Insurers plan to have each block contribute to the contingency reserve (so the full amount contributed to surplus is not paid out in dividend
What are some characteristics of the special treatment of annuities in terms of pricing and dividend policy?
- Expense loading for single premium annuities can exist only in the first year
- Declining death rates among annuitants are likely to erode any margins that the actuary has included in mortuary assumptions
- Dividends are seldom used in annuity contracts
- Excess earnings from the interest factor of an immediate annuity purchased with a single premium will decrease each year because the policy reserve declines as benefit payments are made to annuitants
