Chapter 18

I'm not sure I agree with this. When setting surrender values, the company can do so on the basis that it expects the smoothing to be cost-neutral over a long enough period of time. However, bear in mind that there might well be less smoothing of payouts for surrenders, in order to avoid anti-selection: so surrender values may be closer to unsmoothed asset share than to smoothed asset share - as per the use of MVRs on UWP business.

 

In this context, smoothing is normally referring to smoothing out investment return fluctuations: paying higher than (unsmoothed) asset share under poor investment conditions, lower than asset share under strong investment conditions. [The term 'smoothing' could also refer to smoothing across policies, given that the same bonus rates apply to a cohort of policies, rather than each policy having its own rate, hence there being some inevitable cross-subsidies.]

 

Yes I think you might be misinterpreting it. The cashflow addition approach allows more tailored addition of any surrender profits to policies, reflecting the experience within that cohort. (Although it could alternatively be done across a wider range of policies - as we explain in the second paragraph under the heading 'Cashflow addition to asset share' in Section 3.3 of Chapter 18.) The investment return method could be applied by just giving the same additional return to a wide range of policies / products, hence everyone gets the same amount - more broadbrush, less tailored, less reflective of the experience within particular cohorts. However, the latter could alternatively be done by cohort, as we explain in the second paragraph under the heading 'Addition via investment return'.

 

I'm not sure that holds, does it? For surrenders, if we are doing less smoothing then we might find that we are cost-neutral over a shorter time period? In the extreme, if we are doing no smoothing at all, then we are cost-neutral immediately

 

It should be based on benefit in excess of asset share, because that is the amount that actually costs the life insurance company something and so would need to be recovered from the other WP p/hs.

 

Do you mean a proportion of smoothing profit being retained by the estate? That would rely on the company expecting to make such a profit over time, whereas normally such smoothing would be targeted to be cost-neutral. Having said that, as mentioned in Ch 18 Section 3.9, a charge might be deducted from asset shares in order to support the cost of providing smoothing, which is along the same lines (ie transferring something to the estate in relation to smoothing costs).

 

Exactly how the smoothing account operates would be down to the insurer.

I'm not sure what you mean by '+ estate contribution' - do you mean as a sort of 'seed capital' to start the smoothing account off? That would not necessarily be required: there's nothing to say that the smoothing account cannot go negative - it's just a method of monitoring the cost of smoothing over time. As stated in the course notes, companies would generally aim to manage it so that it is close to zero.

Also bear in mind that not all companies would deduct a 'cost of smoothing' charge from asset shares.

And be careful with the final point: it would be more accurate to refer to adding the {difference between unsmoothed asset share and smoothed asset share for all policies becoming claims}. (Actual payouts might be greater than asset share because guarantees are biting, but that would not be part of the 'smoothing' account.)

 

The shadow fund approach is an example of a retrospective accumulation approach. The distinction lies within the mechanism being used: the parallel recording of the unit fund value for each policy on a daily basis (this is the 'shadow fund' - seen only by the insurer), but using actual investment performance rather than simply increasing unit prices by the regular bonus rate.

 

Yes - sounds like you have clicked it now!

In terms of your final question, that's unlikely. The accumulated charges would fall to the estate and remain there, ready to be used to support future smoothing costs.

The reason why charges taken from asset shares might be refunded to p/hs on WP fund closure is that the insurer is going to have to start distributing the estate to the WP p/hs who are in the fund at that point. Giving each p/h back what they have contributed to the estate feels like a reasonable first step in what is a complicated process of working out what a 'fair' distribution of the estate might be to each.