September 2014 - Q1 iii - WP surplus distribution

[Viki2010]

Hi, the ASET solution describes TB as one of the possible methods for surplus distribution.
In this case, wouldn't the distribution only hit the policies which are maturing at that moment or shortly after the distribution date? Or would the company set an account from which the TB be paid out when the policies mature in the far distant future ie. the surplus would not be distributed immediately for a wider pool of eligible policies so the surplus distribution would not immediately decrease the surplus fund.

 

[Lindsay Smitherman]

Using terminal bonus (TB) to distribute surplus (or "estate") would mean giving all WP policyholders a higher TB than they would otherwise have received, whenever they exit - not just those who leave in the short-term. This would typically be done by increasing all asset shares, so that TB rates are then automatically set higher than they would otherwise have been.

Note that even though the surplus would not be being paid out of the fund, this approach would decrease the surplus. This is because the realistic liability (in respect of the benefits that are expected to be paid out in future) will have increased due to the higher expected TB.

However, this approach may be more attractive to the company than increasing RB because TB leaves the company with more flexibility, and there will be less of an impact on surplus because increasing RB will increase the expected cost of guarantees, whereas increasing TB will not.

 

[Sponge]

Using terminal bonus (TB) to distribute surplus (or "estate") would mean giving all WP policyholders a higher TB than they would otherwise have received, whenever they exit - not just those who leave in the short-term. This would typically be done by increasing all asset shares, so that TB rates are then automatically set higher than they would otherwise have been.

Note that even though the surplus would not be being paid out of the fund, this approach would decrease the surplus. This is because the realistic liability (in respect of the benefits that are expected to be paid out in future) will have increased due to the higher expected TB.

However, this approach may be more attractive to the company than increasing RB because TB leaves the company with more flexibility, and there will be less of an impact on surplus because increasing RB will increase the expected cost of guarantees, whereas increasing TB will not.

Using terminal bonus (TB) to distribute surplus (or "estate") would mean giving all WP policyholders a higher TB than they would otherwise have received, whenever they exit - not just those who leave in the short-term. This would typically be done by increasing all asset shares, so that TB rates are then automatically set higher than they would otherwise have been.

Note that even though the surplus would not be being paid out of the fund, this approach would decrease the surplus. This is because the realistic liability (in respect of the benefits that are expected to be paid out in future) will have increased due to the higher expected TB.

However, this approach may be more attractive to the company than increasing RB because TB leaves the company with more flexibility, and there will be less of an impact on surplus because increasing RB will increase the expected cost of guarantees, whereas increasing TB will not.

The solutions also look at surplus distribution by addition to benefits which increases guarantees and so forth.

But, they mention shareholder transfers? Is there a difference in how quickly shareholder transfers are made if the surplus distribution is made to the Asset Shares or made to the Benefit amount?

The solution somehow implied that the surplus distribution by addition to the Asset Share resulted in a delay to shareholder transfers.

 

[Lindsay Smitherman]

Hi

Surplus can be distributed by regular bonus (RB, declared annually, guaranteed once declared), special bonus (SB, one-off, guaranteed once given) or terminal bonus (TB, only given when a policy becomes a claim, not guaranteed).

Shareholder transfers are generated only when a bonus is declared (RB, SB) or when a bonus is paid out (TB). In a 90:10 fund, each of these bonuses will trigger a shareholder transfer equal to 1/9 of the cost of that bonus.

So if there is a one-off SB, this will generate a shareholder transfer at the time at which the SB is added to the policyholders' benefits.

However, if the company decides not to give an SB or to increase RB but instead just to increase asset shares, this means that the amount of TB payable will be higher (since asset shares drive TB rates). So the extra shareholder transfers in this case will only be generated once the extra TB is actually paid out - ie when the policies that are currently in-force become claims and leave the company. Hence this method defers or delays shareholder transfers.

Hope that makes more sense?

 

[Sponge]

I suppose shareholder transfers are related to actually maturity payout or the guaranteed future payouts. Once the contractual obligation to payout has been set up, this triggers a shareholder transfer? I'd assume that surrender value payouts would not necessarily trigger a shareholder transfer as they are unlikely to include bonus declarations but rather closely reflect the Asset Shares. In scenarios where considerations are made for Premiums paid to date vs Asset Share values at early durations and maturity benefit vs Asset Share values at later duration; in these scenarios I suppose the argument is that the shareholder transfers will pay for these considerations.

 

[Sponge]

I also noticed that the solution to Sept 2014 Q1 (iv) barely touched on the fact the organisation's strategy is shifting to without profits business. My solution split the marks 50% on the closure of the with profit fund to NB and 50% on the new without profits strategy. The question was also quite vague asking us to consider the issues surrounding "this decision". What is the best way to tackle such questions that have a lot of scenarios/events and the question doesn't necessarily specify the event of focus?

 

[Lindsay Smitherman]

I suppose shareholder transfers are related to actually maturity payout or the guaranteed future payouts. Once the contractual obligation to payout has been set up, this triggers a shareholder transfer? I'd assume that surrender value payouts would not necessarily trigger a shareholder transfer as they are unlikely to include bonus declarations but rather closely reflect the Asset Shares. In scenarios where considerations are made for Premiums paid to date vs Asset Share values at early durations and maturity benefit vs Asset Share values at later duration; in these scenarios I suppose the argument is that the shareholder transfers will pay for these considerations.

Apologies, I am not sure that I fully understand your argument here, but to clarify:
- the shareholder transfer is triggered whenever a regular bonus is added to a policy (which normally happens at an annual declaration, to all WP policies at the same time) or whenever a terminal bonus is added to a policy (which only happens when a claim payment is made, which could be on death, surrender or maturity, say)
- terminal bonus is often paid on surrender of a WP policy: if the surrender value (as determined by looking at the asset share) is greater than the sum assured plus regular bonuses paid to date, there will be a terminal bonus payment to bring the benefit amount up to the asset share level. Hence when the surrender value is paid, there will be an extra shareholder transfer generated of 1/9 of the amount of TB within that SV.
You seem to be thinking about bonuses and asset shares as being separate things. They aren't: the bonuses are set in order to pay out asset share (on average, over time, allowing for smoothing).

If a company is paying out higher than asset share at early durations, then for WP business it will either pay for that extra cost out of the estate or charge the extra cost (surrender "loss") into the asset shares of those who remain.

 

[Sponge]

Apologies, I am not sure that I fully understand your argument here, but to clarify:
- the shareholder transfer is triggered whenever a regular bonus is added to a policy (which normally happens at an annual declaration, to all WP policies at the same time) or whenever a terminal bonus is added to a policy (which only happens when a claim payment is made, which could be on death, surrender or maturity, say)
- terminal bonus is often paid on surrender of a WP policy: if the surrender value (as determined by looking at the asset share) is greater than the sum assured plus regular bonuses paid to date, there will be a terminal bonus payment to bring the benefit amount up to the asset share level. Hence when the surrender value is paid, there will be an extra shareholder transfer generated of 1/9 of the amount of TB within that SV.
You seem to be thinking about bonuses and asset shares as being separate things. They aren't: the bonuses are set in order to pay out asset share (on average, over time, allowing for smoothing).

If a company is paying out higher than asset share at early durations, then for WP business it will either pay for that extra cost out of the estate or charge the extra cost (surrender "loss") into the asset shares of those who remain.

I understand. Any bonus declaration regardless of claim event would trigger a shareholder transfer.

Any “losses” due to surrender (if surrender payout is higher than assetbshare) , etc are charged to the estate or remaining asset shares.

There are no charges passed on to the shareholder fund. The only scenario when the shareholder fund is affected negatively is when bonus declarations are reduced.

 

[Naimin Patel]

Using terminal bonus (TB) to distribute surplus (or "estate") would mean giving all WP policyholders a higher TB than they would otherwise have received, whenever they exit - not just those who leave in the short-term. This would typically be done by increasing all asset shares, so that TB rates are then automatically set higher than they would otherwise have been.

Note that even though the surplus would not be being paid out of the fund, this approach would decrease the surplus. This is because the realistic liability (in respect of the benefits that are expected to be paid out in future) will have increased due to the higher expected TB.

However, this approach may be more attractive to the company than increasing RB because TB leaves the company with more flexibility, and there will be less of an impact on surplus because increasing RB will increase the expected cost of guarantees, whereas increasing TB will not.

Hi Lindsay,
I'm a little confused about your last statement here. How the TB increases the realistic liability but not the cost of guarantees? I understand why it doesn't increase the cost of guarantees, seeing as the final decision is only made at time of claim. But I didn't think it would increase realistic liabilities as the asset share is greater and so cost of cover in excess of asset share is lower.

 

[Lindsay Smitherman]

There are no charges passed on to the shareholder fund. The only scenario when the shareholder fund is affected negatively is when bonus declarations are reduced.

Yes for 90:10 business. For unitised with-profits business that is written on a "charges" basis in a 0/100 fund, remember that non-investment surplus accrues fully to shareholders - and this could be negative. [As described in Chapter 20]

 

[Lindsay Smitherman]

Hi Lindsay,
I'm a little confused about your last statement here. How the TB increases the realistic liability but not the cost of guarantees? I understand why it doesn't increase the cost of guarantees, seeing as the final decision is only made at time of claim. But I didn't think it would increase realistic liabilities as the asset share is greater and so cost of cover in excess of asset share is lower.

If asset shares are increased, then the future expected TB rates are also increased. The BEL must include holding a liability for future discretionary bonuses. Higher TB -> higher future discretionary bonus -> higher BEL.