Hi, I'm struggling to follow the bold text in the following piece of core reading (page 7, Chapter 19 of CMP): "Some companies may allocate smoothed investment returns to asset shares. Bonuses derived from these asset shares would automatically allow for any smoothing policy. However, this would mean that asset shares allowing for both smoothed and unsmoothed investment returns would need to be monitored to understand the smoothing costs as this approach would not automatically result in smoothing costs which were neutral to the fund. Unsmoothed asset shares are also required in order to monitor payouts relative to target range" Why would a company allocate both smoothed and unsmoothed investment returns to asset shares? If smoothed investment returns were just allocated, would that be smoothing cost neutral to the fund? Appreciate any help. Thanks in advance, Clare
Hi What this means is that the company would need to calculate an asset share allowing for smoothed investment returns (the smoothed asset share) and an asset share allowing for unsmoothed investment returns (the unsmoothed asset share). The 'cost of smoothing' equals the smoothed asset share minus the unsmoothed asset share. When the insurer is smoothing upwards, this is a positive cost; when it is smoothing downwards, this is a negative cost (ie a benefit to the insurer). Smoothing being cost-neutral would mean that the positives and negatives broadly offset against each other, to be zero on average over time. If the insurer calculates an unsmoothed asset share and then applies smoothing to that asset share (or to the payouts based on that asset share), it can do so in a way that aims to be (broadly) cost-neutral. It is easier for the company to monitor how much it is losing when smoothing upwards and how much it is gaining when smoothing downwards. However, if it instead applies smoothing by using a smoothed investment return in the asset share calculation (eg rather than the actual investment return over the previous year, it uses the average over the previous three years) then this sort of rule won't automatically result in smoothing being cost-neutral. And the company would have to calculate both smoothed and unsmoothed asset shares in order to determine what the actual cost of smoothing is over time. Hope that helps?
