Chapter 7 With-profits surplus distribution (2)

Question 1

Describe the revalorisation system of surplus distribution

Answer 1

• Bonuses are granted by increasing reserves, benefits and premiums of with-profits contracts by a percentage, r% say
  Most countries operating this bonus system also offer option of constant premium policies, ie reserves increase by r%, benefits increase by s% (s <=r) and premiums don’t change
  ​
• In determining r%, it’s common to divide surplus into
  savings profits (ie investment surplus) and
  insurance profit (ie surplus from other sources)
• A high proportion of savings profit is usually given to policyholders, with rest retained for shareholders
• All insurance profit may go to shareholders or, depending on market, it may be divided between shareholders and policyholders

Question 2

State 4 advantages of revalorisation system of surplus distribution

Answer 2

1. Simple to apply
   therefore cheap to administer
   exceptions if policyholder takes portion of insurance profits
   one off profits/losses usually spread over time and judgment may be needed
2. Codifies exactly how company should declare part of its profits as bonus, so objective and relatively cheaper to administer
3. Objectivity generally protects policyholders from ungenerous life insurers
4. Takes assets at book value
   thus includes appropriately smoothed writing-up adjustments/smooth emergence of investment profit is usually achieved

Question 3

State 4 disadvantages of the revalorisation method of surplus distribution

Answer 3

1. Company has no discretion (except to extent of spreading of one-off costs, if insurance profits is distributed to policyholders)
2. Tends to discourage equity investment, as there is no deferral of profit distribution.
   meaning all investment losses would be borne by company and would constitute unacceptable insolvency risk
   also problem regarding treatment of unrealised gains, which are not easy to distribute directly under current revalorisation systems
3. Versions that do not share insurance profit with policyholders go against principle of mutuality
4. Difficult to explain to policyholders with constant premiums policies who see very small additions to their guaranteed benefits early in policy term

Question 4

Describe the contribution system of surplus distribution

Answer 4

Distributable surplus should be distributed among policies in same proportion as those policies are judged to have contributed to surplus

Question 5

State a formula for the dividend under the contribution method of surplus distirbution. Define all terms.

Answer 5

Dividend = (V0 + P)(i” - i) - (q” - q)(S - V1) - [E”(1+i”) - E(1 +i)]

Where:

V0 = value of contract at beginning of year on valuation basis

V1 = valut of contract at end of year on valuation basis

P = gross premium

i” = actual rate of interest earned

i = valuation basis rate of interest

q” = actual mortality rate

q = valuation basis rate of mortality

S = sum assured

E” = actual expenses experienced under contract

E = valuation expenses under contract

Question 6

State 3 advantages of the contribution method of surplus distribution

Answer 6

1. Policyholders receive benefits earlier than under additions to benefits or revalorisation methods
2. Objective, so more transparent and may appear fairer
3. Equitable (dividends based on policy’s contribution to surplus)

Question 7

State 3 disadvantages of the contribution method of surplus distribution

Answer 7

1. Payment of cash dividend reduces final benefit. May not be popular if policyholder wishes to pay set premium or is targeting a set benefit for specific purposes
2. Overall return may be lower, as no deferral of surplus (unless there’s a terminal dividend)
3. Increased admin of making dividend payments….need to ensure system is set up for the change

Question 8

List

3 influences on policyholder’s expectations as regards the form of the profit distribution and level of bonuses or dividends given
3 potential consequences of a failure to meet those expectations

Answer 8

• Influences on policyholder’s expectations
  documentation issued by insurer
  company’s past practice
  general practice in life insurance market
• Possible consequences of failure to meet those expectations
  policyholder dissatisfaction
  risk of losing existing and/or new business
  intervention by insurance supervisory authority in affiars of company

Question 9

State 2 possible benefits of deferring distribution of profits to policyholders.

Give 3 features of an additions to benefits surplus distribution system that could be used to help defer distribution of profits to policyholders

Answer 9

• Deferring profit may be
  used to augment company’s free assets and it ability to take on risk
  available to support new business (depending on the regulatory regime)
• Using additions benefits system to defer profits distribution
  high proportion of terminal bonus (and lower reversionary)
  conventional with-profits (rather than accumulating with-profits)
  super-compound bonuses (rather than compound or simple)

Question 10

List 4 aims of profit distribution strategy

Answer 10

• To meet PRE regarding payouts and to treat customers fairly
• To meet shareholders’ requirements for profit from company’s with-profits business (where appropriate)
• To manage capital efficiently/control solvency risk
• To control marketing risk