With profits (BONUS)

Question 1

How can surplus be distributed?

Answer 1

• Reduction in premiums
• Cash bonus
• Benefit increase

Question 2

What are the 3 forms of increasing benefits?

Answer 2

•   1. Conventional additions to benefits / conventional with profits
    2. Accumulating with profits

• Revalorisation
• Contribution

Question 3

How do the 3 forms of increasing benefits compare with regard to equity and smoothing?

Answer 3

Addition to benefits:
- Deliberate smoothing of asset share volatility over time
- Sharing of mortality and expense experience is very broadly equitable

Revalorisation:
- Equitable distribution of investment profit. Mortality and expense profit not usually included.
- Could be some smoothing over time using the valuation method.

Contribution:
- Very equitable re ibvestment, mortality and expense surplus.
- Some smoothing

Question 4

How do the 3 forms of increasing benefits compare with regard to flexibility / discretion?

Answer 4

Addition to benefits:
- Maximum flexibility to company
- Can decide how much and when

Revalorisation:
-No discretion- codified

Contribution:
- Considerable equity for total distributed; total is plit by fairly fixed rules. However, some judgement required as to how group policies for application of the formula

Question 5

How do the 3 forms of increasing benefits compare with regard to simplicity?

Answer 5

Addition to benefits:
- Simple to tell policyholder what is being done
- Harder to explain or justify
- ph must have trust in industry

Revalorisation:
- Simple to apply and explain to ph

Contribution:
- Simple to apply and explain to ph

Question 6

How do the 3 forms of increasing benefits compare with regard to flexibility / discretion?

Answer 6

Addition to benefits:
- Delibirate smoothing of asset share volatility over time
- Sharing of mortality and expense experience is very broadly equitable

Revalorisation:
- Equitable distribution of investment profit. Mortality and expense profit not usually included.
- Could be some smoothing over time using the valuation method.

Contribution:
- Very equitable re ibvestment, mortality and expense surplus.
- Some smoothing

Question 7

What are the 5 ways in which bonus methods be used in the company’s financial management

Answer 7

1. Margins for future adverse experience
2. Business objectives of the company to maximise profit distribution to shareholders
3. PRE
4. Capital provisions

Question 8

How can the existence of profits add margins for future experience?

Answer 8

The premium has implict or explicit margins to generate profit. These margins can be looked at as margins against adverse future experience. This manages the risk of actual experience being worse than what was assumed in the pricing basis.

Question 9

What affects the extent to which profit margins can be seen as margins for future adverse experience?

Answer 9

1. PRE may make it difficult to reflect poor experience in declared bonuses
2. Guarantees within w/profits contracts mean there’s a level of adverse experience whereby further losses can’t be recouped.
3. Bonus distribution method. For example, revalorisation only distributes investment profit, so mortality and expense losses borne by company.

Question 10

What is the purpose of a company having business objectives to maximise profit distribution to policyholders?

Answer 10

1. Improve competition risk
2. Manage marketing risk- risk that low bonusses reduce levels of new business, increasubg per-policy expenses for current policyholders.

Question 11

What might influence PRE regarding bonus distributions?

Answer 11

1.Documentation issued by company
2. Company’s past practice
3. General practice in the market

Question 12

What are the consequences of failing to meet PRE?

Answer 12

1. Lose existing and/or new business
2. May be seen as a failure to treat TCF which might be grounds for intervention by regulator.

Question 13

To what extent can the risks arising from PRE be controlled under each bonus method?

Answer 13

Conventional with-profits
- Greatest discretion to control risk, once PRE have been formed, through management of its bonus distributions

AWP
- Future non-guaranteed profit distributions are discretionary, so similar to convention.
- Might be greater expectations of bonuses being linked to underlying investment returns.
- Might make it harder to under delare reversionary bonuses in years of good investment performance.

Revalorisation
- No discretion.
- NB to not raise PRE

Contribution
- Marketing risk of dividend being lower than PRE inhibits bonus deferral by the company
- If significant terminal dividend, may exercise control over this risk with regard to the total payout.

Question 14

What is the effect of deferring profit distribution on capital?

Answer 14

Increase level of free assets&raquo_space;
» increase company’s ability to take on risk and investment freedom

Question 15

To what extent can the company defer profits under each bonus method?

Answer 15

Conventional with-profits
- Greater allocation to terminal bonus = greater deferral
- Super-compounded reversionary bonus method defers profit the most

AWP
- Deferral is less than convention w/profits
- Will depend on bonuses actually declared
- PV of bonuses could be similar

Revalorisation
- None

Contribution
- Depends on balance between regular and final dividends
- Deferral may be significant but to lesser extent than convention w/profits