1) CMP Chapter 21, page 9
“Rate of return required by shareholders will usually exceed the rate at which undistributed surplus accumulates within a life insurance company”.
Why so?
2) CMP Chapter 21, question 21.8
Why is the BEP similar between new business and recently written business?
3) CMP Chapter 21, page 21
Why is competition more important under AWP than CWP?
Why is sustainability of bonus rate less important under AWP than CWP
Thanks!
Hi - let's see whether we can untangle these points as so many of you are interested!
1) The undistributed surplus in the WP fund would be invested in a mixture of the standard asset types: e.g. cash, fixed interest bonds, equities, property, with a reasonable proportion potentially in the lower risk & lower return asset classes. The shareholders are likely to require a higher return from providing equity to the insurance company than they could receive by investing in these assets, otherwise they would just invest directly in those assets themselves. Also, the accumulation of surplus will incur investment costs and (to the extent to which BLAGAB business) taxation of investment returns, which erodes the rate of accumulation. The conclusion is therefore that the shareholders' required rate of return would exceed the return that would be earned by undistributed surplus. Therefore deferring the distribution of profits to shareholders would, in general, not be a good thing: they would rather have the profits distributed as early as possible e.g. in order to be able to invest them in other ventures that would earn them higher returns.
2) Bonus earning power (the ability of the business to support a certain level of bonus) will depend principally on expectations of future investment returns. This should be similar between business which was written recently and current new business.
3) The solution to Q21.9 says that "arguably" competition is more important under AWP than CWP - so it is not a definitive statement. There is very little conventional with profits business being written in the UK now. And AWP business has tended to be more competitive in terms of comparison of the bonus rates offered, because such policies do not have a sum assured (just a fund value purchased by the premium(s) paid) and so the regular bonus tends to be the most visible component of the benefit or return that the policyholder is receiving.
Sustainability of bonus rate tends to be less important for AWP than for CWP because AWP policies are generally more flexible, e.g. flexibility of premium levels and timings, and because they are more similar to a unit-linked product - hence policyholders tend to be more accepting of variation in bonus levels. Basically, there is less policyholder expectation of continued bonus at the same rate as present under AWP as there is under CWP. [But as the solution says, this is also "arguable", i.e. not necessarily strictly the case.]
Hope that helps.
