Chapter 38: Surplus and Surplus Management

Question 1

Surplus

Answer 1

The value of the assets MINUS the value of the liabilities.

Question 2

Surplus arising

Answer 2

The change in the value of the assets MINUS the change in the value of the liabilities over a period of time.
Equivalent to profit.

Question 3

Sources of surplus to an insurer / pension scheme

Answer 3

differences in actual versus expected
- mortality,
- morbidity,
- withdrawals,
- investment returns,
- expenses,
- commission,
- salary growth,
- inflation,
- tax,
- premiums/contributions,
- new business volumes and mix,
- claim/benefit amounts,
 or a change in the valuation basis

Question 4

8 Reasons why providers analyse surplus

Answer 4

• to show the financial effect of divergences between the valuation assumptions and the actual experience, exposing the most financially SIGNIFICANT ASSUMPTIONS
• to show the financial effect of writing new business
• to VALIDATE the calculations and assumptions used
• to provide a CHECK ON THE VALUATION data and process if carried out independently
• to demonstrate that the sum of the variances in the individual levers equals the total variance
• to identify non-recurring components of surplus, thus enabling appropriate decisions to be made about the distribution of surplus
• to reconcile the values for successive years

to provide:

• management information,
• data for executive remuneration schemes,
• detailed information for the published accounts, and
• information for feedback into the actuarial control cycle

Question 5

Analysis of surplus

Answer 5

Involves splitting surplus down into its component sources.

To do this you need to compare what actually happened over the year, with what you expected to happen.

Question 6

How would you project forward the expected experience?

Answer 6

By using a model that can project items such as the revenue account and balance sheet.
Usually such a model will already exist, such as the usual pricing / profit testing model.

It is important that the model is dynamic.
The projected model output for each policy or 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 previous years needs to be added in.

Question 7

How would you isolate surplus due to sales volumes not being as expected?

Answer 7

The model can be run a second time, but using the actual volumes of business sold rather than the expected volumes of business.

A comparison of the results of this model, with the results of the first model will show sales volume surplus.

Question 8

How would you isolate surplus due to mortality not being expected?

Answer 8

You could run the model using the actual mortality / death claims.

A comparison of the results of this model with the results of the results of the model using expected mortality will show the mortality surplus.

Question 9

Levers on surplus

Answer 9

Factors that management can use to control surplus.

Question 10

7 Examples of how management can control the surplus arising from claims

Answer 10

• monitoring claims experience
• underwriting at outset and at the claims stage
• reinsurance
• no-claims discount schemes
• policy excesses
• tight policy wording
• keeping guaranteed benefits to a minimum

Question 11

5 Examples of how management can control the surplus arising from expenses

Answer 11

• monitoring expenses
• tight budgeting and expense controls
• outsourcing
• making sure that the level of underwriting and claims management is commensurate with the size of the claim
• review of all premiums or variable charges so that they can be increased if expenses turn out to be higher than expected

Question 12

5 Examples of how management can control the surplus arising from investment returns

Answer 12

• monitoring investment returns
• matching assets to liabilities to avoid reinvestment risk
• diversification
• investing in less volatile assets
• tax efficient investments

Question 13

4 Considerations affecting how, when and to whom an insurance company will distribute a positive surplus

Answer 13

• whether the company is proprietary or mutual
• the business objectives of the company and the working capital needed
• the form of the distribution and whether this enables the company to defer distribution (e.g. regular vs terminal bonuses)
• policyholders’ expectations

Question 14

7 Considerations affecting how, when and to whom a defined benefit pension will distribute a positive surplus

Answer 14

• Legislation and whether this dictates which categories of members should have priority for the distribution of surplus
• Tax, since surplus funds may be excluded from beneficial tax treatment
• The scheme rules, which may deliberately have placed restrictions on the use of surplus to avoid potential disputes should it arise.
• Risk, for example if the sponsor bears the risk of making good any deficit, it may be felt that the sponsor should benefit from any surplus.
• The source of the surplus. E.g. if the surplus is from a volatile source, it may be appropriate to retain it as a balance for future volatility.
• The pace of the distribution of surplus, which is often slower than the correction of a deficit.
• Preserving industrial relations with members and employees.