With-profits Surplus Distribution

Question 1

List how profits may be distributed

Answer 1

Cash bonuses
Premium reductions
Benefit increases
- regular
- once-off
- terminal

Additions to benefits
- conventional
- accumulating
Revalorisation
Contribution

Question 2

Key decisions when deciding to distribute profit

Answer 2

1) How much surplus arising can the business afford to distribute
2) How will it split the surplus arising between shareholders and policyholders
3) How will it split the surplus arising among different groups of policyholders

Question 3

Why does the insurer want to defer distribution of surplus?

Answer 3

1) Reduces liabilities comitted, thus reserves required
2) Reduces insolvency risk
3) Increases investment freedom
4) Increases potential future returns on investment

Question 4

List the methods of regular reversionary profit distribution in a conventional additions to benefits method

Answer 4

Simple
Compound
Super-compound

Question 5

Reversionary bonus

Answer 5

Are declared to the benefit during the term of the policy and, once added, cannot be removed (become guaranteed)

Question 6

Terminal bonus

Answer 6

May be paid at claim date, but its amount is not guaranteed

Question 7

Simple reversionary bonus method

Answer 7

Bonuses are declared throughout the term as a percentage of basic benefit only. For a given total amount of reversionary bonus, this method is the least effective at deferring profit and, as a result, the least capital-efficient

Question 8

Compund reversionary bonus method

Answer 8

Bonuses are declared throughout the term as a percentage of basic benefit plus attaching bonuses. For a given total amount of reversionary bonus, this method is moderately effective at deferring profit and, as a result, moderately capital-efficient

Question 9

Super-compound reversionary bonus method

Answer 9

Bonuses are declared throughout the term as different percentages of basic benefit and attaching bonuses. For a given total amount of reversionary bonus, this method is the most effective at deferring profit and, as a result, the most capital-efficient

Question 10

Methods of expressing terminal bonus

Answer 10

1) As a percentage of attaching bonuses only, in which case the percentage may vary with duration in force and original term of contract.

2) As a percentage of basic benefit and attaching bonus, in which case the percentage will vary by duration in force

Question 11

Bonus distributions should…

Answer 11

1) Be in accord with PRE

2) Satisfy the requirements for equity between different groups of policyholders, including different generations

3) Not interfere with the company’s new business plans, investment strategy or solvency

Question 12

Revalorisation method of with-profits surplus distribution

Answer 12

Bonuses are granted by increasing the reserves, benefits and premiums by the same percentage, r%

Question 13

Advantages of Revalorisation method

Answer 13

1) Simple to apply
2) Codifies exactly how a company should declare bonuses
3) Having a codified method protects policyholders from ungenerous life companies
4) Usually requires very little judgement, therefore cheap to administer
5) By taking assets at written up or written down book value, a smooth emergence of investment profit is usually received

Question 14

Disadvantages of Revalorisation method

Answer 14

1) Company has no discretion in its profit distribution
2) This method tends to discourage equity investment, since we’d like stable returns
3) No deferral of distribution of profits
4) Difficult to distribute unrealised gains under this method
5) Versions that do not share insurance profit with policyholders go against the principle of mutuality
6) Not very easy to explain to “constant premium” policyholders who may dislike small initial bonuses

Question 15

The contribution principle

Answer 15

Each policy receives a share of distributable surplus in proportion to its contribution to surplus

Question 16

Contribution method

Answer 16

The most common form of this method uses a formula to identify the investment, mortality and expense profit from sample policies to determine the bonus to be declared.

Question 17

Advantages of the contribution method

Answer 17

1) By varying the amount of distributable surplus over time, a smoothed progression of dividends is achievable
2) Results in an extremely equitable distribution of profit, by relating the distribution to each policy’s contribution to total profit
3) Due to mechanical nature of dividing distributable surplus, less actuarial judgement is required, so this method is relatively cheap to administer

Question 18

Disadvantages of contribution method

Answer 18

1) Not easy to determine how policyholders should be grouped
2) Requires subjective actuarial judgement to determine total distributable surplus each year
3) Does not take explicit account of other sources of surplus, e.g. withdrawal profit or profits from margins in gross premium, these are lumped into “expense profit”

Question 19

Impacts of a reduction in bonus rates

Answer 19

1) injury to company’s competitive position
2) lead to a reduction in new business levels