Chapter 6 With-profits surplus distribution (1) Flashcards
List 3 forms in which profits can be distributed to with-profits policyholders (3)
Cash bonus
Addition to benefits
Reduction of premiums
Explain why the insurer and the with-profits policyholders may have differing views on deferral of distribution of profits to poliycholders
Insurer’s view (2)
With-profits policyholder’s view (2)
From insurer’s POV, deferral of distribution may be attractive because:
increased probability of remaining solvent
greater investment freedom ( future bonuses higher if earn higher returns)
With-profits policyholders may welcome second of these (higher future bonuses), but possible disadvantage of deferral may be:
uncertainty of not knowing how much deferred (terminal) distribution is going to be
What is it that forms part of the profits distributed? (2)
What split/factor is it important for us to consider when deciding on profits to distribute? (2)
Profits usuall constitute
- Excess investment return on premiums paid over the guaranteed return
- Mortality/expense profit
- Usually less significant than investment profit, because
long term mortality/expense experience can be more accurately predicted and
premium basis can be based on more realistic forecast of future
Important to consider split between
profits distributed to shareholders vs profits distrbuted to policyholders
* may be regulation restricted/governed
Name 3 surplus distribution systems (3)
Additions to benefits
* conventional with pofits
* accumulating with profits
Revalorisation
Contribution
List 3 types of conventional with profits bonuses (3)
Regular reversionary bonuses
Special reversionary bonuses
Terminal bonuses
Define reversionary bonus (3)
- Declared during contract lifetime, payable at the same time as basic benefits
- Once declared, is attached to basic benefits and cannot be taken away
- Can be
regular (usually added annually), or
special (added as ‘once off’ from time to time
Discuss the features of the reversionary conventional with profts bonus structures
Regular reversionary bonuses (1,4)
Special reversionary bonuses (1,3)
- Regular reversionary bonuses
bonus rates may change, unless investment/ecnonomic conditions change over time
determining rates:
gradual change over time
insurer prefer lower for lower guarantees
greater protection against market falls, since declared bonuses gauranteed
fewer subsidies between generations - Special reversionary bonuses
doesn’t create expectations of similar increases in future
one-off profits/special circumstances e.g. demutualisation, take-over, restructuring with profits fund
increases gaurantee faster than if regular reversionary used
Describe the 3 types of regular reversionary bonus for conventional with-profits policies (3)
What can be said about level of profit deferral achieved by each? (1)
- Simple: bonus expressed as % of basic benefit
- Compound: bonuse expressed as a % of basic benefit plus any already attaching bonuses
- Super compound: bonus expressed in terms of two %s
one applied to basic benefit
second applied to any already attaching bonuses
For given total amount of reversionary bonus at maturity date of an endowment, deferral of distribution is greatest with super compound, and least with simple bonus
Define terminal bonus (3)
State 2 ways in which it can be speficied for conventional with-profits policies (2)
What kind of profit sources are terminal bonuses usually used to distribute? (1)
What is the general/guiding principle used to determine the level of terminal bonus to distribute? (3)
Terminal bonus
* Additional amount payable when insured event occurs.
* Determined when insured event occurs.
* Genereally more volatile as company has greater scope to increase if needed.
TB may be specified as:
* % of total attaching reversionary bonuses possibly varying with duration in force
* % of total claim amount (basic benefits plus attaching reversionary bonuses) before addition of terminal bonus
Profit source distributed by terminal bonus
* Usually used to distribute profits from more volatile sources rces e.g. capital gains on equity
Usually set as difference between asset share and guaranteed benefits
* because aim is to distribute profits to policyholders, allowing for shareholder’s interest and other aspects such as cost of capital.
* insurer tracks asset shares of sample policies to determine if affordable terminal bonus.
Explain what is meant by accumulating with-profits (AWP) contract (3)
What form of contract may AWP take? (2)
Comment on the guarantees we may find on AWP contracts (2)
What kind of death benefit may be payable on AWP contracts? (3)
Definition
1. Bonuses are added in relation to premiums paid to date plus previously declared bonuses
2. Premiums regular or single
3. Terminal bonus may be added when policy becomes claim
Form of AWP contracts? May be unitised or non-unitised
Gurantees given on AWP
1. Guarantees likely less than on CWP because bonuses are declared on current benefit rather than sum assured
2. May be gauranteed minimum accumulation rate
Death benefits can be
1. guaranteed sum assured
2. return of premiums
3. return of FV
What are the key differences between unit-linked contracts and unitised accumulating with-profits contracts in terms of
unit price (2)
surrender value (2)
- Unit price
UL: set objectively by direct reference to value of underlying
WP: set at discretion of company, so only indirect link with value of underlying assets - Surrender values equal
UL: bid price of allocated units less any surrender penalty specified in contract. Company has no discretion.
AWP: bid price of allocated units plus terminal bonus (if appropriate) less any surrender penalty specified in contract less any MVR that company may have right to apply
Describe 2 basic ways in which the unit part of a unitised accumulating with-profits contract could operate
Unit price remains constant e.g. R1.00 and bonuses are granted by allocating additional units
* company allocates additional units to each contract, usually annually at bonus declaration. these are made up of (possibly zero) guaranteed addition, and bonus addition, which could also be zero especially if there are guaranteed additions
* number of units is determined at discretion of company
Bonuses are granted by increasing unit price, usually on a daily basis.
* increase is made up of (possibly zero) guaranteed part and bonus part.
* increase in UP is at discretion of company
Under both methods, terminal bonus coud be added when claim event happens
Bonus distribution considerations
Bonus distributions should:
be in accord with policyholders’ reasonable expectations
satisfy the requirements for equity between different groups of policyholders,
including the different generations
not interfere with the company’s new business plans, investment strategy or
solvency.
To fix loss in With Profits
Selling a new tranche of with-profits business can enable the company to ring-fence the existing losses, so that new business will not have to adhere to the same bonus rates. [½]
Having completely different benefit and bonus structures should make it easier for the insurer to pay more realistic bonuses on the new contracts. [½]
If part of the problem is to do with mis-managed PRE, then the new structure gives the company a fresh opportunity to get PRE properly set from the outset, for example during the sales process, and so reduce the risk of similar problems happening in the future. [1]
The accumulating with-profits (AWP) structure is more transparent to policyholders. This willmake it easier for policyholders to appreciate when bonus rates are high relative to currentmarket interest rates (for example), so possibly making a future reduction in bonus rates (if it follows market movements) more acceptable. [1]
