Smoothing

[Helloall]

Hi,

I was wondering whether you could perhaps explain a component of smoothing to me.

I understand that an individual who takes out a with profits contract will experience smoothing e.g. actual returns in first 3 years are 5%, 10%, 6% whilst regularly revisionary bonuses are say 5%, 5% and 5%.

I also understand that at the end of the contract you pay a terminal bonus in order to payback the rest of the earned asset share on the contract i.e. you are trying to pay asset share to the policyholder.

What i don't understand is that in certain past papers it implies that the asset share is not always paid out and an average asset share is paid out e.g. at maturity sometimes a policyholder will receive more than the asset share and sometimes they will receive less. Why does the terminal bonus not just mean that they receive the asset share. Is it because you are not performing these calculations on a per policy basis and doing it on groups of policies?

 

[Mark Willder]

Hi,

I was wondering whether you could perhaps explain a component of smoothing to me.

I understand that an individual who takes out a with profits contract will experience smoothing e.g. actual returns in first 3 years are 5%, 10%, 6% whilst regularly revisionary bonuses are say 5%, 5% and 5%.

I also understand that at the end of the contract you pay a terminal bonus in order to payback the rest of the earned asset share on the contract i.e. you are trying to pay asset share to the policyholder.

What i don't understand is that in certain past papers it implies that the asset share is not always paid out and an average asset share is paid out e.g. at maturity sometimes a policyholder will receive more than the asset share and sometimes they will receive less. Why does the terminal bonus not just mean that they receive the asset share. Is it because you are not performing these calculations on a per policy basis and doing it on groups of policies?

Your understanding above is all correct. So we have two types of smoothing: smoothing regular bonuses and smoothing payouts. If with-profits policies just paid out exactly the asset share then there wouldn't really be much difference between with-profits and unit-linked. So smoothing the maturity payout is a fundamental feature of with-profits. Yes, sometimes an element of smoothing is introduced by setting terminal bonuses for groups of policies rather than considering individual asset shares. But even companies that calculate individual asset shares might smooth these to calculate the payout.

Best wishes

Mark