PARTICIPATING LIFE INSURANCE CONTRACT

INTRODUCTION

CONVENTIONAL PARTICIPATING/ WITH-PROFITS CONTRACTS

• Policy where the policyholder are guaranteed a certain level of benefit (the sum assured) in return for the payment of fixed single or annual premium.

• Policyholder has an entitlement to part or all of any future surplus which arises under the contract. (Participate in the profits earned by the fund.

OPERATIONS OF THE FUND

Figure 1: The operation of a with-profits fund*α is the proportion of distributed profit which is attributed to the shareholders.

What Type of Surplus for Distribution ?

• Excess investment return on the premiums paid, over and above the guaranteed return.

• Profit from mortality or expense experience being better than allowed for.

• Some of this surplus may have arisen from “non-participating” (ie without-profits or unit-linked) policies.

Possible Ways of Distributing Profits

Cash Bonus Premium Reduction Benefit Increase

Addition to benefit Method

Revalorization Method

Contribution Method

Possible Ways of Distributing Profits

• As a cash/ dividends to the policyholderCash Bonus

• As a reduction to the premium payable during the next year.

• The reduction would be equal to the amount of cash that would have been payable in cash bonus

Premium Reduction

• To be used as a single premium to purchase additional contractual benefit

• The bonus is left in the fund to accumulate on deposit

• To be used as a single premium to purchase additional death benefit i.e 1 year term assurance

Benefits Increase

Distributions Method - Additions to Benefits Method

Conventional With-ProfitsThe initial guaranteed sum assured (“basic benefit”) may be increased by bonuses of three kinds:

• Regular reversionary bonuses, added throughout the contract term. • A Special Reversionary bonus, added as a “one-off” from time to time. • A Terminal Bonus, paid when the contract reaches maturity and possibly also on

death or surrender.

The distributed profits are paid out along with the original sum assured when there is a contractual claim under the contract, for example at death or maturity.

Distributions Method - Additions to Benefits Method

A regular reversionary bonus is a reversionary bonus that is declared on a regular basis, usually each year, throughout the lifetime of a contract. • The amount of bonus can be calculated 3 ways

i. Simple bonus - is expressed as a percentage of the basic benefit under the contract

ii. Compound – the bonus is expressed as a percentage of the basic benefit plus any already attaching bonuses.

iii. Super compound – the bonus is expressed in terms of two percentages , one applied to the basic benefit and a second applied to any already attaching bonuses. Typically, the second percentage is higher than the first.

Distributions Method - Additions to Benefits Method

The amount of Reversionary Bonus can be calculated 3 ways:

• bt is the bonus rate declared for year t• S is the guaranteed sum assured under a policy• Bt is the total reversionary bonus for year t• NBt is the new bonus for year t

i. Simple bonus –> NBt= bt S

ii. Compound –> NBt= bt ( S + Bt)

iii. Super compound –> NBt= b(s)t S + b(b)t Bt

Distributions Method - Additions to Benefits Method

Example 1:

Compare the build up of sum assured over the lifetime of a 15-year policy with the following alternative methods, assuming an initial sum

assured of £10,000:

• simple bonus at 5% pa

• compound bonus at 3.9% pa

• super compound bonus at 3% pa on basic sum assured, 7.5% pa on bonuses

1 2 3 4 5 6 7 8 9 10 11 12 13 14 1510000

11000

12000

13000

14000

15000

16000

17000

18000

SBCBSCB

Distributions Method - Additions to Benefits Method

Special Reversionary Bonus

A company may declare part or all of a reversionary bonus as a one-off “special”, in addition to any regular reversionary bonus that it is giving. This may, for example, occur as the result of restructuring a with-profits fund.

Distributions Method - Additions to Benefits Method

Terminal Bonus• The amount of terminal bonus is determined when the insured event occurs.

(constantly changing bonus)

• It defers the distribution of surplus until the end of the contract, and so slows down the build-up of guarantees under the contract.

• The bonus to give to particular contact may be specified in a number of different ways: (Refer to the Example 2)

i. A percentage – possibly varying by duration in force and original term of contract (total of attaching reversionary bonuses including any special reversionary bonuses.

ii. A percentage of the total claim amount – before addition of terminal bonus, with percentage varying according to duration in force.

Distributions Method - Additions to Benefits Method

Example 2:Twenty-five year with-profits endowment assurance, maturing now Guaranteed sum assured (basic benefit): RM5,000Attaching reversionary bonus: RM5,950Terminal bonus as a percentage of reversionary bonus only: 58%Terminal bonus as a percentage of sum assured plus reversionary bonus: 31.5% Terminal bonus in either case: RM3,450Total payout in either case: RM14,400

Distributions Method - Additions to Benefits Method

Accumulating With-Profits

• Bonus are added annually in relation to the premiums payable to date plus previously declared bonuses.

• A terminal bonus maybe added when the policy becomes a claim n maturity, death or surrender.

• The most common form of such contracts is what is described, for marketing purposes, as a “unitised with-profits” contract.

• A non-unitised accumulating with-profits contract can look and operate very much like a conventional with-profits contract with recurring single premiums.

Distributions Method - Additions to Benefits Method

Accumulating With-Profits

The following shows the relationship between policy benefit values:

Ft+1 = ( Ft + Pt – ct ) (1 + bt)

where: Ft = policy benefit (excluding terminal bonus) at policy time t; F0 = 0 Pt = premium paid at policy time tct = charge deducted at time tbt = regular bonus added between times t and t +1.

Distributions Method - Revalorisation Method

• The profit to be given to a particular contract is expressed as a percentage of, r%, of that contract supervisory reserve. (the amount distributed to a policy with current reserve Vt would be rtVt

• There are two methods of distributing this amount to policyholders; first is to increase both the policy benefits and the future premiums by the same proportion rt .

• Thus, the benefit under the contract and the premium payable by the policyholder are increased by the same amount.

• The profit of the life insurance company is divided into saving profit and insurance profit.

Distributions Method - Revalorisation Method

• The saving profit represents the profit from asset and can be distributed by revalorisation method.

• The insurance profit is that arising from actual experience being better than expected for all sources of profit other than the return on the asset.

• This insurance profit typically be retained by company for distribution to shareholders.

Distributions Method – Contribution Method

The “contribution principle”, which underlies this approach, is that distributable surplus should be distributed among policies in the same proportion as those policies are judged to have contributed to surplus.

Distributions Method – Contribution Method

The dividend given to a particular contract is calculated using the following formula:

The gross premium in the policy above is the actual premium paid by the policyholders.

Distributions Method – Contribution Method

The three components of the formula:

• Excess interest on the {reserve plus premium}, ie interest surplus. (The premium is assumed payable annually in advance in this formula.)

• The expected death strain less the actual death strain, ie mortality surplus.

• Excess of expected expenses over actual expenses, accumulated to the end of the year, ie expense surplus.

Discussion

1. Give and example of a risk that may be higher for a with-profits policy than for an equivalent without-profits one.

2. Why not simplify the system and allocate bonus only as terminal bonus, with no reversionary bonus?

Case Study

The following example illustrate on how a conventional with-profits fund operates.

Case Study

Assumptions:• 10,000 identical policies are issued at time t=0• The actual experience is exactly the same as that expected according to the

premium basis.• The benefit paid on death during the policy year t will be equal to

Bt = (SA) x (1 + RB at time t) x ( 1 + TB)

• The accumulation of the fund is described by the following formula Ft+1 = Ft + Pt + It – Et – Ct

Where,

Ft – the assets (fund) accumulated by the beginning of year t and

Pt , It , Et , Ct – the total premium income, investment income, expenses and claim outgo incurred during year t

Case Study

The Annual Office Premium = RM142.95

Fill in the blank and produce the solutions by using excel. Show the working for the annual office premium. (10% Assignment Marks) – Due Date 23/2/15