Chapter 38: Surplus and Surplus Management Flashcards
Profit
Difference between revenues and expenditure.
Surplus
The difference between the value of the assets and the value of the liabilities.
Surplus arising
The surplus arising over any time period is the change in the surplus over the time period. Surplus arising is equivalent to profit.
Analysis of surplus (or profit)
A breakdown of the surplus arising over a year into its constituent parts.
A provider will want to analyse the surplus arising in order to (12)
ASSISTING MANAGEMENT IN DECISION MAKING
- give information on TRENDS in the experience of the provider to feed back into the actuarial control cycle.
- Show the FINANCIAL EFFECT OF WRITING NEW BUSINESS
- determine the most FINANCIALLY SIGNIFICANT ASSUMPTIONS
- IDENTIFY non-recurring components of surplus
- provide MANAGEMENT INFORMATION
- show the FINANCIAL EFFECT OF DIVERGENCES between the valuation assumptions and the actual experience
DATA AND CALCULATION CHECKS
- RECONCILE the values for successive years
- demonstrate that the variance in the financial effect of the individual levers is a complete description of the variance in the total financial effect
A/L VALUATION CHECKS
- provide a CHECK on the valuation data and process, if carried out independently
- VALIDATE the calculations and assumptions
INFORMATION FOR OTHER PURPOSES
- provide data for use in EXECUTIVE REMUNERATION SCHEMES
- provide detailed INFORMATION for publication in the provider’s accounts
3 Main sources of surplus
- Decrements
- Cashflows
- Other factors
Levers on surplus / profit can be used to (6)
- reduce the likelihood of claims (eg good underwriting)
- reducing claim / benefit amounts (eg using reinsurance to limit claims or protect vs risk of large claims)
- control expenses
- increase renewals and/or reduce lapses
- follow an investment policy that increases investment returns (subject to an acceptable level of risk)
- adopt and effective tax management policy.
For a LIFE INSURANCE company, the factors that will affect the amount of surplus distributed are (6)
- provision of capital
- margins for future adverse experience
- business objectives of the company
- policyholder expectations
- shareholder expectations
- other stakeholder expectations (including staff)
The decision of how to apply the surplus / deficit in benefit scheme will depend on (6)
- risk exposure of the various parties
- source of the surplus or deficit
- legislation
- scheme rules
- discretion of the sponsor/managers
- expected effect of that decision on industrial relations
Sources of surplus under:
- Decrements
- new business levels,
- withdrawal / lapses,
- mortality
- morbidity
Sources of surplus under:
- Cashflows
- premiums / contributions paid
- investment income and gains
- claim amounts
- expenses
- commission
Sources of surplus under:
- Other factors
- salary growth
- inflation
- taxation
How would management:
- reduce the likelihood of claims
- Cost-effective claims management procedure eg. periodically reviewing ongoing claims
- good underwriting of new business
- good underwriting at the claim stage
- providing customer incentives not to claim
How would management:
- reduce claim / benefit amounts
- using reinsurance to limit the volatility of claims or to protect from the risk of large claims
- reducing future benefit payments
- keeping guaranteed benefits to a minimum
- introducing / increasing excesses
How would management:
- Control expenses
- periodically reviewing expenses
- keeping charges / premiums flexible
- ensuring that claims expenses are commensurate with the claims size
Reversionary bonuses
These regular bonuses are added to the sum assured during the life of a policy. Once a reversionary bonus is attached it is a legal liability of the company, ie the guaranteed benefits of the policy has increased
Terminal bonus
These final bonuses are added only at the time a claim is made. Terminal bonuses are not guaranteed.
3 ways for a benefit scheme to reduce or remove a surplus:
- increase the value of the benefits and hence the value of the liabilities
- reduce future contributions for a period of time, so that the surplus decreases gradually as additional liabilities accrue.
- transfer all or part of the excess assets from the scheme - eg to the sponsor as a refund of contributions paid of to the beneficiaries as a one-off benefit payment.
Discuss the impact of the valuation basis on the surplus arising.
The choice of valuation basis WILL NOT AFFECT THE TOTAL AMOUNT OF SURPLUS ARISING over the life of a contract (which will depend solely on the difference between the actual experience and that assumed in pricing the contract).
It WILL AFFECT THE TIMING of the emergence of the surpluses during the life of the contract.
- Think about the valuation of provisions to be kept aside.
- If the reserve valuation basis is made more conservative, larger reserves defer profits and taxes to a later date.
3 Main groups of reasons reasons for performing an analysis of surplus/profit.
- Assisting the management in decision making
- Data and calculation checks.
- Providing information for other purposes
Reasons for an analysis of surplus/profit:
Assisting the management in decision making
(5)
- Show the FINANCIAL EFFECT OF DIVERGENCES between the valuation assumptions and the actual experience, exposing the assumptions which are most financially significant.
- Show the FINANCIAL EFFECT OF WRITING NEW BUSINESS
- Identify non-recurring components of surplus, thus enabling appropriate decisions to be made about the distribution of surplus.
- Provide MANAGEMENT INFORMATION
- Give information and TRENDS IN THE EXPERIENCE of the provider to feed back into the actuarial control cycle.
Reasons for an analysis of surplus/profit:
Providing information of “other purposes”
(2)
- Provide data for use in executive remuneration schemes
- Provide detailed information for publication in the provider’s accounts.
Reasons for an analysis of surplus/profit:
Data and calculation checks
(4)
- Validate the calculations and assumptions used
- Provide a check on the valuation data and process, if carried out independently
- Reconcile the values for successive years
- Demonstrate that the variance in the financial effect the the individual levers is a complete description of the variance in the total financial effect.
How might a model be developed to compare actual versus expected experience?
The model is developed by multiplying the (unit) profit test results 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.
This will give a model that can be used to build up the expected future progress of the business as shown by the revenue accounts.
As time goes on, a second model can be built up from the original profit test, but using the actual volumes of business sold, rather than expected volumes.
Comparison of actual results with this model will identify whether differences between actual and expected outcomes are due to:
- difference between actual and expected experience, or
- sales volume being different from expected.
