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Surplus and surplus management (Reasons why providers analyse surplus…
Surplus and surplus management
Surplus and surplus arising
Surplus
Assets - liabilties
Surplus arising
Change in value of assets less change in value of liabilities over a period of time. Surplus arising is equivalent to profit.
Often surplus arising is referred to simply as surplus.
Reasons why providers analyse surplus (DIVERGENCE)
Information to management and for accounts
Experience monitoring to feedback into ACC
Reconcile values for successive years
Variance as a whole is equal to the sum of the variances from the individual levers
Divergence of A vs E (show financial effect/ significance of
Group into one-off/ recurring sources of surplus
Executive remuneration schemes (data for)
New business strain (show effects of)
Check on valuation assumptions and calculations
Extra check on valuation data and process
Projecting experience in an analysis of surplus
Usually such a model will already exist, for example to the original pricing or profit testing model
It is important that the model is self-consistent, i.e. assumptions and different elements of the output are mutually consistent
The projected model output for each model point is scaled up by the expected number of contracts to be sold in each future year
Use a model capable of projecting items such as the income statement (revenue account) and balance sheet on the expected experience basis
Then, for each future year, the number of contracts still in force from previous years needs to be added in.
This enables expected future revenue accounts and balance sheets for the business to be built up.
Isolating surplus from...
Sales volumes
Run model a second time using actual volumes of business sold rather than expected volumes. A comparison of the results of this model with the results of the first run of the model will show sales volume surplus.
Mortality
Rum model again, using the actual number of deaths and actual benefits paid. A comparison of the results of this model with the model above will show mortality surplus
Sources of surplus
Demographic
Mortality/ morbidity
Withdrawals
New business volumes/ new business mix
Economic
premiums received
expenses, including commission
Inflation (price and salary)
Investment income and gains
Tax
Change in the valuation bases or method used
Counterparty failure/ business restructuring
Importance of analysis of surplus
Part of the 'monitoring the experience' stage of the ACC
Provide feedback into the contract design process.
Many life insurance contracts are long term and general insurance claims may be long tailed. Waiting until all risks have gone off the books could take years. It is not practical to wait so long to find out whether a contract is profitable or not, since, in the meantime, many more tranches of business will have been written and the insurance company will not want to make the same mistakes
Levers on surplus :
Factors that management can use to control the amount of surplus arising
Controlling claim frequency
Monitor claims experience
Good underwriting of new business
Good claims management systems
Eligibility criteria
Tight policy wording
Customer incentives not to claim (e.g. no claims discount systems)
Policy excesses
Controlling claim/ benefit amounts
Reduce future benefit payments, e.g. by increasing the age of eligibility or by removing an inflation link
Provide rehabilitation services (income protection insurance)
Good claims management systems
Tight policy wording
Reinsurance
Keep guarantees and options to a minimum
Policy excesses
Monitor claims experience
Controlling expenses
Expense budgeting and monitoring
Variable charges/ premiums
Ensure that underwriting and claims expenses are commensurate with the size of the claim
Policy excesses so that small claims (and the associated expenses) are avoided
Increasing renewals/ reducing withdrawals
Maintain competitive premiums
Offer loyalty discounts
Provide good customer service and claims handling
Undertake marketing activities to promote the brand
Impose surrender penalties/ offer no benefit on surrender
Have automatic renewals
Issue renewal notices
Monitor renewal/ withdrawal experience
Claw back commission from brokers on policies are withdrawn
Reduce risk of investment return deficit
Matching (nature, term currency)
Subject to this, select investments to maximise overall return
Diversification by asset class and by stocks within a class
Track an index or competitors' fund allocations
Select low variance investments
Tax-efficient investments
Controls on investment expenses
Monitor investment experience
Effective tax management
Utilise tax allowances fully
Use tax-efficient investments
Pay tax on time to avoid penalties
Issues re amount of life insurance company surplus distribution
Constitution of the company
Provision of capital- deferring the distribution of surplus is a source of capital. Whether deferral is possible depends on the form of the distribution
Margins for adverse experience- the pace of distribution is unlikely to match the pace at which profit arises. Sustained over-distribution drains free assets; sustained under-distribution may not meet policyholders' expectations
Business objectives- maximising distributions to improve competitive position (and generate business) vs maintaining surplus (as a cushion against risk, for writing new business and investment freedom)
Stakeholders' expectations (policyholders and shareholders)- failure to meet these may lead to loss of business or supervisory intervention
Uses of surplus in a benefit scheme
Return to sponsor (not always allowed)
Reduce contributions
Enhance benefits
Retain as a cushion against adverse experience
Considerations when a DB scheme distributes surplus
Legislation and whether this dictates which categories of members should have priority for the distribution of surplus
Tax, since surplus funds may be excluded from beneficial tax treatment
The scheme rules
Discretion of the sponsor/ scheme managers
Risk- e.g. if the sponsor bears the risk of making good a deficit, may be felt sponsor should benefit from a surplus
The source of the surplus- e.g. does it 'belong' to certain members? Does it arise from a volatile source?
Preserving industrial relations with members and other employees
Speed of corrective action