Q3 2011 April ii)

[Helloall]

Must confess I didnt really understand this question.

ii) Can i ask why i am not correct in thinking that only a cash payout is a suitable approach?

If i increase the "benefits" using the addition to benefits or revalorisation approach I increase all of my annuity payouts (today and in the future). Hence i cant do the very thing that this product does -

"Annuity benefits can reduce from one year to the next but cannot be less than the initial annuity".

e.g. I cant reduce the annuity payouts back to their initial amount if future surplus is negative using these approaches.

Any approach to the addition to benefits wont allow me to do this, no? Only a payout via cash allows me to achieve this goal as it dosent increase the benefits and thus the benefits/ annuity payout can be maintained at their initial amount (if the suplus is negative) and if the surplus is positive a cash payout can be made.

 

[Mark Willder]

Must confess I didnt really understand this question.

ii) Can i ask why i am not correct in thinking that only a cash payout is a suitable approach?

If i increase the "benefits" using the addition to benefits or revalorisation approach I increase all of my annuity payouts (today and in the future). Hence i cant do the very thing that this product does -

"Annuity benefits can reduce from one year to the next but cannot be less than the initial annuity".

e.g. I cant reduce the annuity payouts back to their initial amount if future surplus is negative using these approaches.

Any approach to the addition to benefits wont allow me to do this, no? Only a payout via cash allows me to achieve this goal as it dosent increase the benefits and thus the benefits/ annuity payout can be maintained at their initial amount (if the suplus is negative) and if the surplus is positive a cash payout can be made.

Hi

This was a really tricky question that everyone found difficult at the time. With-profits annuities aren't covered in any detail in the SP2 course, so the examiners weren't expecting students to know exactly how they work. The way bonuses are applied to annuities isn't quite the same as for the contracts we are familiar with - credit would have been given for alternative interpretations as long as they were explained. For example, in our ASET at the time we agreed with you that RB didn't really work and wrote:

"Reversionary bonuses would be suitable to distribute the surplus. Once the reversionary bonus was declared all future annuity payments would be increased by this amount. This would lead to a steadily increasing income stream especially if the bonuses were smoothed, which may be appealing to the policyholder.

However, the contract design allows the annuity benefit to reduce from one year to the next as long as it does not fall below the initial annuity. Reversionary bonuses would not allow the annuity to fall in this way."

So we're saying that yes you can use RB for some with-profits annuities, but not for this particular contract given that it says that benefits can be reduced back to the initial guarantee.

Given that the question is for 8 marks, we know that it won't be enough to cover just cash payouts. The command verb is discuss, so we should outline each surplus distribution method and give reasons why it works and why it doesn't as with the ASET example above.

Best wishes

Mark