Factors affecting the degree of smoothing

[prachi]

Hi,

While going through the points in chapter-20, I got confused with concept of smoothing. Could you please:

Que 1. Help me to understand the ways in which smoothing can be done?
I understand so far that it can be done in two ways:
a. Investment return are smoothed which then lead to smoothed asset share.
b. Payouts are smoothed like terminal bonus.
Is there any other way as well?

Que 2: Page 13 mentions about the "Method of distribution" as one of the factor affecting degree of smoothing. I am unable to understand the below para...
"Some examples of different combinations of reversionary bonus and terminal bonus, and how they
might affect smoothing, are described briefly below:
 regular bonus only
A company that declares only a regular bonus is likely to smooth payouts more than one
which incorporates a large element of terminal bonus. This is because it is much harder
to ‘hit’ the earned asset share without using a terminal bonus. However, it may smooth
its reversionary bonus rates less than other companies, because the reversionary bonus
rate is the only tool it has for adjusting payouts.
 large proportion of volatile terminal bonus
A company that declares a large proportion of its benefits as terminal bonus might choose
to match earned asset shares fairly closely, and thus to engage in less smoothing.
 large proportion of smoothed terminal bonus
Alternatively, a company with a large proportion of terminal bonus might choose to
smooth to a large degree (if it can afford to, eg if it has a strong capital position)."

Could you please explain this?


Thanks you so much in advance.
Regards,
Prachi

 

[Em Francis]

Hi Prachi

Please see my comments below:

Hi,

While going through the points in chapter-20, I got confused with concept of smoothing. Could you please:

Que 1. Help me to understand the ways in which smoothing can be done?
I understand so far that it can be done in two ways:
a. Investment return are smoothed which then lead to smoothed asset share.
b. Payouts are smoothed like terminal bonus.
Is there any other way as well?

You can also smooth reversionary bonuses and the actual asset share (as well as terminal bonuses applied). The following thread might help: https://www.acted.co.uk/forums/index.php?threads/smoothing.9960/#post-46920

Que 2: Page 13 mentions about tww.acted.co.uk/forums/index.php?threads/smoothing.9960/tagshe "Method of distribution" as one of the factor affecting degree of smoothing. I am unable to understand the below para...
"Some examples of different combinations of reversionary bonus and terminal bonus, and how they
might affect smoothing, are described briefly below:
 regular bonus only
A company that declares only a regular bonus is likely to smooth payouts more than one
which incorporates a large element of terminal bonus. This is because it is much harder
to ‘hit’ the earned asset share without using a terminal bonus. However, it may smooth
its reversionary bonus rates less than other companies, because the reversionary bonus
rate is the only tool it has for adjusting payouts.

As asset share is following the market then it can be volatile and if RBs are the only way of achieving the asset share then these may have to be volatile to be able to payout asset share (the second point). However, what the first point is saying is that the target may be a smoothed asset share as opposed to the unsmoothed asset share. And this is probably because policyholders will not expect volatile RBs.

 large proportion of volatile terminal bonus
A company that declares a large proportion of its benefits as terminal bonus might choose
to match earned asset shares fairly closely, and thus to engage in less smoothing.
 large proportion of smoothed terminal bonus
Alternatively, a company with a large proportion of terminal bonus might choose to
smooth to a large degree (if it can afford to, eg if it has a strong capital position)."

Policyholders expect more volatility with TBs, so a company which declares a high proportion of TB may look to payout unsmoothed asset share as opposed to smoothed asset share as they have this mechanism. This may be preferable as there is a cost to smoothing which will need to be funded. Whereas if they have a strong capital position and can fund this cost of smoothing then they may apply more smoothing, potentially making it more attractive for policyholders.

Could you please explain this?


Thanks you so much in advance.
Regards,
Prachi