CT5- With-profit policies

[Bharti Singla]

Hello everyone

Please help me to understand the concept of bonus in with-profits policies. At first, I got the reason of how bonuses arise under a policy. The reasons of it are as follow:
•The investment returns on assets are greater than assumed.
•Number of death claims is lower than assumed.
•The amount of expenses is lower than assumed.

That is okay, that the insurer make slightly prudent assumptions about interest rate, mortality and expenses when setting premiums and then bonus will arise if these assumptions are proved better than assumed.

But as I moved towards the chapter, I found that they have turned to a different point. Now, they are saying that the company decides the bonuses to be given in advance and calculate the premium accordingly i.e. charge higher premium than before!
Then what is the significant of bonus if the policyholders are paying extra premium for it? If this is the way, then the companies would introduce a lesser amount of initial benefit(£60000 instead of £75,000 say) to the policyholders and then declare a bonus of £15000 to attract the policyholders!
The concept of bonus is vanished then?

I just want to know how and why would companies anticipate the amount of bonuses and price the product accordingly? Why not it can be so simple that the company decide premium as usual i.e. as in the case of without-profit policies and give the bonus if any, arise in future when the investment returns and mortality proved better than assumed?

Could anyone please explain how the with-profit policies work practically?
I would be really thankful for your help.

 

[Robert Chadburn]

The idea is to make profits larger, so that a significant bonus can be added. Two reasons:-
- if company is less profitable than assumed basis then it can declare a lower bonus rate than anticipated (so the policyholder takes the "risk" of making losses as well as benefiting from profits). This enables the insurer to invest more freely and so can hopefully take the risks needed to make good investment profits, for example.
- so that there is a difference compared to the equivalent without-profits policy. So- a with-profits policyholder pays a higher premium than a without-profits policyholder would for the same sum assured. In return, the with-profit policyholder shares in the experience of the company - gets a better payback if the experience is better than anticipated, and a lower payback if the experience is worse than anticipated. For the without-profits p/h their return is guaranteed.

 

[Bharti Singla]

Got it sir. Thank you