A question on page 7 of SA2-03 asks "Explain why payouts on 25-year conventional with-profits endowments might fall despite having investment returns of 10% over the year". I have difficulty in understanding what it is trying to ask and the answer provided. Could anyone help with this, please? Thank you. Answer is "The returns 26 years ago might have been greater than 10% and these would no longer be relevant for the latest 25-year maturities". Where is the 26 from? Does it mean that the policy will mature in 25 years from today and 10% is only the investment return in year 1 of the policy?
Consider the following: a) A 25 year policy that matured in 2018. The contract would therefore have been written in 1993. b) A 25 year policy that matured in 2019. The contract would have been written in 1994. The solution is highlighting that different generations of policyholder may have experienced different investment conditions and therefore payout levels (eg broadly 100% of asset share). The policy from a) would have earned the return in 1993 but not the return in 2019 as the policy had already matured. Similarly, the policy from b) would have earned the return in 2019 but not the return in 1993 (ie 26 years ago). The payout of the 25 year policy that matured in 2018 would be higher than the 25 year policy that matured the following year if the return in 1993 exceeded the return in 2019. For completeness (but outside the scope of the question): I wouldn’t be surprised if the payout was materially higher in this case given the effect of compound interest. The effect of compounding would probably mean that the 1993 return could actually be less than the 2019 return. And support higher 2018 payouts relative to the 2019 payouts the following year (all else equal).
