Bonus rates for participating products in a Covid-19 world

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A group of Life actuaries, working as part of the IFoA Covid-19 Action Taskforce, are releasing a series of blogs considering various ways that the pandemic has affected Life insurers. In the second blog in this series, they explain how Covid-19 has created uncertainty and what it is important to think about when setting valuation assumptions for bonus rates.

Key highlights of these products:

  • Products participate in the profits of the insurance company –called With-Profits in the UK
  • Premiums are pooled and the pooled fund is used for claims
  • Insurers look to distribute part of the profit as a bonus/dividend
  • Bonuses are of two types – annual and final
  • Once an annual bonus is added it cannot be taken away
  • Bonuses are calculated using several factors including investment returns and actuarial assumptions (expenses, mortality etc)
  • Bonuses are smoothed, some profits are held back in good years to give better returns in poor years
  • There are two main sorts of plans - traditional/conventional or unitised
  • A Market Value Adjuster/Reduction can be applied to reduce the amount paid out, like a negative final bonus.

In setting valuation assumptions for bonus rates, we expect insurers would start from the latest bonus declaration. There are a few things to think about when considering whether any changes should be made:

1. Year-end regulations

In the UK and Europe, the valuation basis is realistic and so makes an allowance for future bonuses. The valuation regulations also allow for the impact of management actions. If solvency is a worry for the insurer, bonuses may be reduced. In the longer term the insurer may look to change the mix of bonuses between annual and final. The insurer may change how it invests, looking for more certainty eg bonds rather than equities.

The biggest impact of Covid-19 is to make things uncertain. It will be important to explain the reason behind the method and assumptions. Insurers will need to think about whether they need to carry out a wider range of stress and scenario testing to better understand the impact of different potential scenarios. It may be sensible to consider whether it is better to update year-end work to allow for the development of the pandemic.

2. Bonus calculation regulations

In the UK, details of the bonus approach is set out in the Principles and Practices of Financial Management (PPFM) document. This sets out the basis of asset share calculation, the mix of annual and final bonus, the investment philosophy on which bonus calculation is based, and the smoothing approach. The asset share calculation determines the level of bonuses that can be paid. This then helps set the bonuses that will apply over the next period. This will use assumptions for expenses, lapses, investment returns and mortality.

Covid-19 may impact the overall principles and practices. Insurers should review their PPFM documents to ensure they are still appropriate for a Covid-19 world.

Even if the principles and practice are unchanged, Covid-19 may still affect the assumptions made for the asset shares. Insurers should consider whether they are still valid. If they are not, the next question will be whether the data is available to make any adjustments. Does a change need to be made urgently or is there a little more time that can be taken? The timing of the changes will also need to be considered.

How Covid-19 will affect smoothing is difficult to assess. Insurers will need to think about whether they need to change the groupings of policies that have the same bonus rates in light of Covid-19. Covid-19 will affect some policies more than others and insurers will want to try to assess this. There may need to be a change in the number of groupings to allow for this. Some insurers look to have a smoothing account that is zero over a certain timeframe. This might need to be extended to allow for Covid-19.

Knock-on impact:

Any changes in year-end models, more scenario testing or more frequent running of the models will have a resource impact.

Any change in bonus rates as a result of the valuation work will need to be communicated to policyholders. This may need to differ from previous communications to take account of Covid-19. Insurers will want to keep an eye on what others in the market are doing.