Chapter 38 - Surplus & Surplus Management

Question 1

Why perform an analysis of surplus/profit ?

Answer 1

A provider will want to analyse the change in any surplus arising over a year or a longer period of time in order to:

Assist 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 divergences between the valuation assumptions and the actual experience
- determine the assumptions that are the 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

Providing information for Other Sources:
- provide data for use in executive remuneration schemes
- provide detailed information for publication in the provider’s accounts

Data and Validation Checks:
- demonstrate that the variance in the financial effect of the individual sources is a complete description of the variance in the total financial effect
- 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

Question 2

Sources of surplus

Answer 2

Possible sources of such surplus / profit (deficit / loss) include deviations between actual vs expected for :
- mortality
- morbidity
- claim frequency
- claim amounts
- withdrawal / lapses
- investment income and gains expenses
- commission
- salary growth
- inflation
- taxation
- premiums / contributions
- new business levels

Other sources of surplus (or deficit) can arise as a result of more strategic events, such as:
- failure of reinsurer or of derivative counterparty
- restructuring of the business / fund, such as bulk sales or acquisitions.

A change to valuation methods or assumptions may also lead to surplus (or deficit). The impact of assumption changes depends on the extent to which assets and liabilities are matched.

Question 3

Levers on surplus

Answer 3

The levers that can control the amount of surplus / profit are the factors that the provider can affect by using management controls to increase value

1. Reduce the likelihood of claims through:
   - good underwriting of new business
   - good underwriting at the claim stage
   - providing customer incentives not to claim
2. Reduce cost of claims through:
   - cost-effective claims management procedures e.g. by periodically reviewing ongoing claims
   - 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
3. Control Expenses:
   - periodically reviewing expenses
   - keeping charges / premiums flexible
   - ensuring that claims expenses are commensurate with the claim size
4. Reduce the number of contracts that lapse or that do not renew at the renewal date
5. Follow an investment policy that increases investment returns (subject to an acceptable level of risk)
6. Adopt an effective tax management policy.

Question 4

Surplus Distribution for different types of companies

Answer 4

For with-profit life assurance business some or all of the distributable surplus is allocated to policyholders in the form of bonuses

A mutual insurance company has no shareholders and thus all the distributable surplus belongs to the policyholders.

or all other corporate institutions the surplus belongs entirely to the shareholders, and the only decision the directors of the company have to make is the extent to which it is retained in the business or distributed as dividends to shareholders

For benefit schemes any surplus is usually retained within the scheme, and may be used to:
- enhance the benefits of members, or
- reduce future contributions of members and/or the employer

Because it is usually difficult to remove benefit enhancements once awarded, changes in contribution rate are normally the first choice. In some jurisdictions it is possible for surplus to be repaid to the scheme sponsor, and in others it is not.

Question 5

Issues surrounding amount of surplus to distribute

Answer 5

For a life insurance company the key factors that will affect the amount of surplus distributed are:
- provision of capital
- margins for future adverse experience
- business objectives of the company
- policyholder expectations
- shareholder expectations
- other stakeholder (including staff) expectations

Benefit Schemes
- Legislation is likely to be the major factor in determining the application of surplus or deficit.
- If a benefit promise has been made, legislation may insist that the benefit is provided whether or not any funds set aside prove to be sufficient.
- There may be a legal obligation on a sponsor to make good any deficit, even if doing so results in the insolvency of that sponsor, and affects other interests of employees, such as their continued employment
- Legislation may also require surplus to be used to increase the benefits being provided, and may even dictate which categories of members should have priority for such increase
- Where legislation does not restrict the application of surplus or deficit, the sponsor can choose to place restrictions on the use of surplus, deficit, or both when setting up the scheme through which the benefits are provided
- If there are no detailed restrictions from the State or in the rules of the scheme, the sponsor or the managers of the fund may be able to choose how to apply any surplus or deficit
- distribution of the surplus also depends on the source of the surplus itself and how it came about