surrender profits on with profits policies

[Flamy]

The notes introduced two methods of allocating the surrender profits on with profits policies:

method 1: cashflow addition to the asset share
method 2: addition via investment return

Cashflow addition is intuitive and it was mentioned as one of the miscellaneous profits for asset share. However addition via investment return sounds complicated in that the increase in investment return would be difficult to quantify I assume? Also the investment return is used to project future policy related liabilities for the next, say 50 years, so this increase seems onerous to me, especially compared with cash flow addition, which is one off?

Can someone comment on method 2 please? Thank you.

 

[Mike Lewry]

Using Method 2, the profit would be allocated to AS by increasing the investment return for just the year the profit is in respect of. The following year's profit would be allocated as a different increase in investment return for that year. And so on.

To quantify it, you could see what difference a 0.1% increase makes to total asset shares and then scale accordingly. So not too onerous.

 

[Flamy]

Thanks very much for the explanation Mike, that is very clear!

Using Method 2, the profit would be allocated to AS by increasing the investment return for just the year the profit is in respect of. The following year's profit would be allocated as a different increase in investment return for that year. And so on.

To quantify it, you could see what difference a 0.1% increase makes to total asset shares and then scale accordingly. So not too onerous.

 

[kidstyx]

I just want to add a question to this.

I don't see why the addition to investment return would necessarily be considered as a broader type of allocating surrender profits compared to cashflow addition (as this is how I understood the core reading), if investment returns can be adjusted for in individual asset shares.

Is it because the investment return is likely to be in relation to a segregated fund or because it is set as a "global parameter" across more than one product type?

 

[cjno1]

I might be wrong, but I thought that the two methods were different in how they rewarded different cohorts of policyholders.

For example, under the cashflow method, you might allocate £50 to every policy's asset share, and so this rewards all customers equally for the profit generated on surrenders.

However, under the investment return increase method, you are actually rewarding customers who have bigger policies (generally those with more money or who have been policyholders for longer) i.e. if you increase the investment return by 1%, someone with £1,000 only gets an extra £10, whereas someone with £100,000 gets an extra £1,000.

If you think about it, this would be a reasonable way to reward policyholders, since bigger policies generally cross-subsidise smaller policies and so should benefit more from ad-hoc profits.

Of course, you could achieve the same result with the cashflow method by saying "this policy will get £10, this policy will get £50", etc, but this would be a very tedious process, and also policyholders might not understand or be happy that that someone else is getting more than they are. It's much easier to sell "everyone gets an extra 1%" as fair.