Surplus And Surplus Management Flashcards
Surplus
The difference between the value of the assets and the value of the liabilities. Surpluses (or deficits) may appear and disappear as the contract’s experience unfolds
The surplus arising over any time period is the change in the surplus over the time period. Surplus arising is equivalent to profit
Reasons for performing an analysis of surplus/profit
An analysis of surplus (or profit) is a breakdown of the surplus arising over a year into its constituent parts
A provider will want to analyze surplus arising in order to:
• 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
• validate the calculations and assumptions
• provide a check on the valuation data and process, if carried out independently
• identify non-recurring components of surplus, to help make decisions about distributing surplus
• reconcile the values of successive years
• provide management information
• provide data for use in executive remuneration schemes
• provide information for the provider’s accounts
• demonstrate that the variance of the parts is a complete description of the variance of the whole
• give information on trends in the experience of the provider to feed back in the ACC
Carrying out an analysis of surplus
To analyze the performance of a product, set of products or an entire financial service product provider over a period, the actual results obtained should be compared tenth those that were expected
The expected results can be modelled by using the models produced at the product development stage. The assumptions within the models should be mutually consistent
By applying the expected new business and renewal levels to such models and aggregating the results, sets of revenue accounts can be developed. The relationship between the elements of the modelled revenue accounts should be mutually consistent. These modelled accounts can be compared with the actual accounts to derive the deviation from expected
The deviation can be analyzed to help answer the questions arising, particularly concerning the investment returns obtained and the product development and other costs incurred. Expenses should ideally be analyzed in the form of unit costs rather than total amount
Sources of surplus/profit
Actual vs expected experience in terms of:
• claims - mortality, morbidity, claim frequency, claim amounts
• volume - new business levels, withdrawal/lapses
• other cashflows - investment income and gains, expenses, commission, premiums/contributions paid
• other factors - salary growth, inflation, taxation
Other sources:
• strategic events, e.g. failure of counterparty, business restructure
• change of valuation method or assumptions (depending on matching)
Sources of surplus/profit
Actual vs expected experience in terms of:
• claims - mortality, morbidity, claim frequency, claim amounts
• volume - new business levels, withdrawal/lapses
• other cashflows - investment income and gains, expenses, commission, premiums/contributions paid
• other factors - salary growth, inflation, taxation
Other sources:
• strategic events, e.g. failure of counterparty, business restructure
• change of valuation method or assumptions (depending on matching)
Levers in surplus/profit
They can be used to try to:
• reduce the likelihood of claims, e.g. through good underwriting
• reduce the cost of claims, e.g. through claims management procedures or by using reinsurance
• control expenses
• increase renewals and/or reduce lapses
• follow an investment policy that increases investment returns (subject to an acceptable level of risk)
• adopt an effective tax management policy
Distribution of any surplus/profits arising
For life insurers:
Distributable profits is allocated to with profit policyholders and/or shareholders or retained as working capital
For other corporate institutions:
Surpluses belong to shareholders and is either
• retained in the business
• distributed as dividends
For benefits schemes:
Generally any surplus is retained within the scheme, and may be used to enhance benefits of the members, or to reduce future contributions of members and/or the employer. It may or may not be possible to return the surplus to the sponsor
Issues surrounding the amount of surplus to distribute
For life insurers the factors that affect the amount surplus distributed are:
• provision of capital
• margins for future adverse experience
• business objectives of the company
• policyholder, shareholder and other stakeholders (including staff) expectations
For a benefit scheme, the factors influencing the decision about the application of surplus or deficits are:
• legislation - likely to be the major factor
• scheme rules
• tax treatment
• discretion of the sponsors/managers
If the sponsors or managers of the fund are able to decide how to apply the surplus or deficit, this decision will depend on the:
• risk exposure of the various parties
• source of the surplus or deficit
• expected effect of that decision on industrial relations
Where surplus is to be applied to the advantage of the sponsor, or deficit is to be made good by the sponsor, a further decision would be required relating to the pace at which this will happen
