With-profits technical provisions

Hi

You don't need to worry too much about the separation of the calculation - it is for disclosure/presentation purposes.

The discretionary benefits include both terminal bonus and future reversionary bonuses. Once declared, future reversionary bonuses will increase the guarantee under the product - and so will increase the cost of guarantee within the BEL (it is a market consistent valuation of the liabilities, so will need to include the time value of the guarantees). However, terminal bonuses are not guaranteed and so do not increase the cost of guarantee element of the BEL. Hence a bonus strategy which is more weighted towards terminal rather than (future) reversionary bonus will accrue lower additional guaranteed benefits in future. Hence the cost of guarantees under that product will be lower than if there was a higher expected weighting towards reversionary bonus, and therefore the BEL (which includes the cost of guarantees) will be lower.

A special bonus is normally a one-off which arises due to a specific situation, e.g. as a result of an estate distribution exercise. The company does not have to include anything in the BEL for such a bonus until the time at which it decides that it is going to declare one. But as soon as it decides that it is going to declare a special bonus at some point in the future, it needs to include that in its BEL.

Hope that makes things clearer? Do of course come back and post again if you need more help.

 

Thanks Amit - agreed: nice point!

Also: companies have to perform a separate calculation of the present value of shareholder transfers that relate to future (discretionary) bonus declarations, and this value then forms a separately identified part of "own funds" (as mentioned in Section 2.1 of Chapter 12). Again looking from the practical perspective, this calculation can be made easier through having a separate valuation of the future discretionary bonuses.

[Bear in mind that you are not expected to know factual points of detail that are not included in the Core Reading.]

 

The total BEL for a with profits policy will very basically be the asset share (which includes accrued terminal bonus) plus the cost of inherent guarantees (and with adjustment as necessary to allow for smoothing). The cost of guarantees element is typically determined using a stochastic modelling approach and will need to reflect future expected reversionary bonus (RB) declarations (which will add to future guarantees) and not just guarantees that have already built up. Therefore an assumption will need to be made about future RB rates. These are likely to be set to vary dynamically within the stochastic model, i.e. lower RB rates in the simulations which have poor investment returns.

Comparing projected asset share to projected maturity value is about comparing values as at the maturity date. Comparing asset share to a GPV is about comparing values now. They are doing the same thing, just at different points in time. [Broadly speaking, the first comparison is {asset share now + future premiums - future expenses + future investment return} v {maturity value}. The second comparison is {asset share now} v. {maturity value + future expenses - future premiums - future investment return (due to discounting)}. So they are equivalent.]

The "surplus" which we refer to when talking about bonus declaration basically arises due to the components which increase an asset share (in practice it's a little more complicated than that, but hopefully this simplification makes it easier to understand). As an asset share increases, we need to get that increase to the policyholder somehow (since the asset share represents what the policyholder is entitled to) - and the only way to do this is via bonus (either now via RB or in the future via TB). So investment return (net of charges/expenses etc) increases the asset share, generates "surplus" (in this context) and then needs to be allocated to the policyholder via a combination of regular and terminal bonus. [Asset shares increase by premiums too, of course, but these are (partly) needed to pay for the underlying guaranteed benefit, so only the "explicit bonus loading" part would fall into the "surplus" that is used for bonus distribution.]

 

The supportability investigations are used by companies to determine the maximum levels of RB rates that they can expect to sustain throughout the remaining lifetime of the policies, and this helps them to decide on an appropriate level - as policyholders will prefer RB rates not to change too frequently. TB rates are set using the process described in Section 5.4 of Chapter 21, i.e. basically set in order to pay out asset share. Considering the source of the "surpluses" arising would be one factor that the company would consider when deciding on its RB rate, alongside others (including the supportability investigation mentioned here). The RB allocates to the policyholder some of the "surplus" each year, the rest is allocated at the time of claim via the TB.

 

The BEL already includes allowance for the future bonuses, and any guarantees relating to them. Therefore, if the RB is declared at the same rate as was expected in the previous BEL calculation there would be no change (ignoring the impact of rolling forward by one period of course). If the declared RB is lower than that expected, the BEL would reduce (lower cost of guarantees) and vice versa if higher than that expected.

Yes, a declared bonus could increase the amount payable on death and hence increase the deduction made to asset share for the cost of life cover, but bear in mind that this is a relatively small amount since is multiplied by a mortality rate (or, equivalently, the amounts paid out to those who have died are spread out over the much larger number of in-force surviving policies).

If you performed another sustainability investigation then the outcome would depend on things like what the investment return had been over the period since the previous investigation. The act of declaring a RB in itself would not impact the outcome of the investigation, provided the rate is broadly in line with the sustainable rate.

Apologies but I am not quite sure that I understand your final question. The asset share represents the accumulation of assets in respect of each policy. The inherited estate increases(+)/decreases(-) as a result of investment return on the assets in which it is invested (+), any expenses/tax which the company requires the estate to support (-), charges taken from asset shares (+), enhancements to asset shares (-) and the cost of paying benefits in excess of asset share (-).

Hope that helps & sorry if I have misunderstood anything.

 

Hi Viki: asset share

 

Hi - might be worth stepping back a bit from this and thinking about what the basic calculation is: a valuation of the expected (projected) future liabilities. The easiest way to determine the two components of a with profits BEL is to start by calculating the total BEL.

The basic calculation for the total BEL would be the present value of expected total future benefits (i.e. both those that are currently guaranteed and discretionary future benefits) + expenses - premiums. Expected total future benefits would, for a with profits product, be based on the higher of smoothed asset share and the underlying guaranteed benefits at the time of claim (e.g. at maturity). Or in other words, on smoothed asset share + cost of guarantee, with the latter being defined in terms of the excess of guaranteed benefits over asset share. Because you need to model the probability of the guarantee biting, a stochastic model would normally be used.

To calculate the BEL for guaranteed benefits only, you do the same as above but only for the guaranteed benefit element - and so you would not necessarily have to use a stochastic model. The BEL for discretionary benefits is then the difference between these two calculations.

Bear in mind that future discretionary benefits can include future reversionary bonus, which will contribute to the cost of guarantees element once declared, and that asset share covers both guaranteed benefits awarded to date and accrued (discretionary) terminal bonus. So you cannot simply split asset share & cost of guarantee elements into guaranteed & discretionary elements.

Hope that helps give a little more clarity?

[Note that the precise treatment of future reversionary bonuses within the split of guaranteed and discretionary benefits is one area of evolving industry practice under Solvency II, with different companies currently taking different approaches, so you would not be expected to have a detailed knowledge of this for the exam.]

 

Hi - yes, your second point is correct (not your first one).

The guarantees provided by the basic sum assured and regular bonuses which have been declared up to the valuation date may "bite" at the claim date, and this forms part of the (market consistent) "cost of guarantees" element of the BEL.

And then future regular bonus becomes guaranteed once declared, and this also has to be allowed for in the BEL - so further increases the "cost of guarantees" within the BEL.

Hope that helps.

 

Hi - this sounds broadly correct, since AWP will be valued as for any other type of with-profits business.

If there are no guarantees at all, then the benefits part of the BEL will be based simply on smoothed asset share and, as you say, there is no "cost of guarantee" element. Projecting forward the smoothed asset share will allow the company to model the expected future bonuses that would be added to the current benefit.

Where (as is more typical) there is an inherent guarantee, then benefits will normally be based on the higher of the guaranteed amount and the smoothed asset share (other than at points in time when an MVR can be applied).

The benefits that have built up to date form the guaranteed element of the BEL (this is not quite the same thing as valuing "premiums to date", as it also needs to take into account bonuses declared to date and charges deducted).

The discretionary element reflects the future bonuses that are projected to be added, and most companies include both future regular and future terminal bonus in this element. Bear in mind that future regular bonuses normally add to the inherent guaranteed benefit level, and so there is an extra "cost of guarantee" part of the discretionary element of the BEL.

And finally, future premiums (and the benefits relating to them) would be allowed for in the BEL if the contract boundary has not yet been reached.

 

It means the total value of the guarantee, both intrinsic and time value.

Yes except that the company would be projecting the smoothed asset share as this is what payouts are based on if the guarantee doesn't bite. [The overall BEL should also reflect cost of smoothing.]

 

Yes, or you could assume that it is the same as in the previous year (as companies try not to change RB rates too frequently). More normally, the RB rate would be programmed into the stochastic model so that it would vary appropriately in each future projection time period according to the conditions under each simulation, and according to whatever management action rules the company would normally apply to its RB rates.