1. Cyber risk and Terrorism risk - Challenges in pricing
27th India Fellowship Seminar
Cyber risk and Terrorism risk - Challenges in pricing
How critical the built up of estate is in participating fund
and
How best that can be utilised for the benefits of all stakeholders?
Guide: Philip Jackson
Presenters: Sunil Vishnu Savalkar
Shalmalee Prakash Paralkar
Neha Aggarwal
Supervisor:
P.A. Balasubramanian, FIAI
1st & 2nd June 2017
Mumbai
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2. Indian Actuarial Profession Serving the Cause of Public Interest
Agenda
Cyber risk and Terrorism risk - Challenges in pricing
INTRODUCTION
HOW IS ESTATE GENERATED?
WHO ARE THE STAKEHOLDERS?
WHY TO HAVE ESTATE?
ESTATE – BEST UTILISATION
ESTATE – IS THERE AN IDEAL LEVEL?
Supervisor:
P.A. Balasubramanian, FIAI
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Introduction
What is a With-Profit / Participating (Par) contract:
A contract where policyholder participates in any surplus / profits emerging i.e. the policyholders get a share of profits from the policy
Cyber risk and Terrorism risk - Challenges in pricing
IRDAI (Distribution of Surplus) Regulations, 2002 states that the shareholders shall be allocated “1/9th of the surplus allocated to the participating policyholders”.
Thus, policyholder : shareholder share the surplus in 90:10 proportion.
What is Asset Share:
GN6 defines asset share as “…the accumulation of the premiums received plus investment income earned from the inception, less deductions due to benefit payments, commission, expenses, tax, a reasonable cost of capital and of guarantees, contribution from miscellaneous surplus (if considered appropriate) and transfers to shareholders”.
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Introduction
What is Estate:
IRDAI (Preparation of Financial Statements and Auditor’s Report of Insurance Companies) Regulations, 2002 defines FFA as “The FFA shall represent all funds, the allocation of which, either to the policyholders or to the shareholders, has not been determined by the end of the financial year”.
Estate can be defined as:
“excess of par assets over those required to meet the reasonable expectations of existing participating policyholders”; or
“excess of par assets over reserves or asset share”; or
“the undistributed surplus in with-profit fund.”
There is no standard definition of estate. So for our discussion we will not restrict ourselves to any specific definition of estate, but try to cover generic points on the topic.
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How is estate generated?
Profits from surrendered policies
Surrender benefit should represent asset share: IRDA (Non-Linked Insurance Products) Regulations, 2013
Excess of asset share over surrender benefit is surrender profit.
If not allocated to asset share – contributes to estate when estate is defined as “assets over asset share”
Deferral of distribution of surplus
Entire emerged surplus may not distributed – Some portion of it may be retained to act as buffer against adverse events
If estate is considered as “assets in excess of reserves”, then such undistributed surplus contributes to estate.
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How is estate generated?
Deductions from Asset Share
Cost of capital and cost of guarantees deducted from asset share contribute to estate – if estate is defined as “assets over asset share”
Riders attached to par policies
Riders attached to par policies are written in the par fund.
Riders have potential to generate significant profits
Such rider profit can’t be distributed as and when it arises
This rider profit contributes to estate
Non par business written in par fund
Historically, non participating business allowed to be written in the Par fund
Profits from such business can’t be distributed as and when it arises
This profit contributes to estate.
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How is estate generated?
Tax Credit
Tax is payable on distributable surplus.
Tax may not be payable at the company level, due to past accumulated losses.
Tax savings contribute to estate.
Contributions by Shareholders
Contributions from shareholder a major source of estate in UK(1)
In India, shareholders can inject, only to declare bonus if par fund is in deficit and in the first 12 years of the par fund.
Alternatively, shareholders can retain their share of distributed surplus in the par fund – contributing to the estate.
(1) The UK House of Commons, Treasury Committee’s Report, 2008
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Who are the Stakeholders?
POLICYHOLDER
Contributes to the par fund by way of premiums
Expects good and stable returns in form of bonuses
Entitled to receive 90% of the distributable surplus.
SHAREHOLDER
Injects capital to makeup for deficit in par fund
Expects speedy recovery of capital
Entitled to receive 10% of the distributable surplus
MANAGEMENT
Manages the par fund
Remuneration linked to performance of the par fund
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Who are the Stakeholders?
DISTRIBUTOR
Interacts with policyholder in the field
Expects good sales story aided by historically competitive bonuses
REGULATOR
Ensures fair treatment and security to policyholder
Lays down the operational framework for business
Ensures compliance with the regulations
For our further discussions, we will consider the policyholder and shareholder as the primary stakeholders.
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Why to have estate?
1. To pay higher than asset share
To fund the payouts greater than the asset share
Payouts greater than asset share happen due to
smoothing principles of the company or
due to guarantees provided or,
due to competitive pressures..
The company can use estate to
pay higher bonuses in a falling market
cut the bonuses slowly
2. Provides investment freedom
Improves risk taking capability in the investment strategy
Allows investment in volatile but high return generating assets
Helps increase the return on the fund over longer term
Results in better returns to the policyholders and shareholders.
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Why to have estate?
3. Funds the new business capital strain
Writing new business may give rise to capital strain
Can be funded by estate
Allows to write new business with higher guaranteed component
Avoids a strain on the solvency position of the company due to writing of new business
4. Absorb expense over-runs
Expense over-run = Actual expense – Expense allowances
Historically, expense overruns partly allocated to the estate
IRDAI regulation on Expenses of Management may curtail such practice
5. Improves Solvency
Estate forms part of free surplus
Improves solvency ratio
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Why to have estate?
6. Withstand adverse events
One off events can arise either from insurance risk or market risk
Helps absorb the losses in the event of one off events
Supports one-off development costs incurred for par business
7. Lower cost of reinsurance
Allows to increase exposure to mortality risk
Provides ability to absorb mortality variation
Retention limit could be increased
Reduces dependency on reinsurer and in turn reduces counterparty risk
8. Increases Goodwill
Increases probability of meeting PRE
Improves financial strength by giving ability to withstand risks
Improves credit rating
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Estate – Best Utilisation
SMOOTHING OF BONUS
Shareholders prefer early return on their investment – higher regular bonus and low terminal bonus - fluctuation in regular bonus would be acceptable.
Policyholder expects steady bonuses in line with PRE created by illustrated bonuses, past declared bonuses and bonuses declared by other companies
Appointed Actuary needs to maintain a balance between the two opposite expectations
Bonus sustainability to be examined under various scenarios (of investment return, policyholder behaviour, mortality or one off loss) before increasing regular bonuses.
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Estate – Best Utilisation
FLEXIBILITY IN INVESTMENT STRATEGY
Shareholders as well as policyholders expect higher returns
Availability of estate allows investment in riskier asset classes like equity and property - raising possibility to earn higher investment returns
Too risky assets may adversely impact the size of estate
Appointed Actuary needs to evaluate and recommend appropriate investment strategy that would maintain a balance between risk and reward
Appointed Actuary should sensitise the management against investment in too risky assets
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Estate – Best Utilisation
SUPPORT NEW BUSINESS CAPITAL STRAIN
Shareholders will expect writing new business with lower capital injections in the par fund
New products with higher guarantees can be introduced
These may affect policyholders interest in the estate
Appointed Actuary must ensure that the policyholders funding the capital are not unduly penalised
Policyholders’ capital needs to be treated the same way as the shareholder capital.
Credit may be given in the computation of asset share of such policyholders
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Estate – Best Utilisation
ABSORB EXPENSE OVER-RUNS
Acquisition expenses higher than those implicit in benefit illustration may be allocated to estate - it is in the interest of shareholders.
This, however, may not always be in the best interests of the policyholders.
Regulation on Expenses of Management issued by IRDAI limits allocation of such expense over-runs.
Appointed Actuary and Chief Financial Officer must ensure that expenses are allocated and apportioned to the par fund appropriately
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Estate – Best Utilisation
DECLARING SPECIAL BONUS
Shareholders may prefer early release of estate for speedy returns on their investment
Policyholders will also expect a fair share of estate
Different generations of policyholders may have contributed differently to the estate
Appropriate consideration needs to be given to each generation while determining their share of special bonus – Equitable distribution of surplus
Consideration needs to be given to solvency position before and after special bonus
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Estate – Best Utilisation
GENERATING GOODWILL
Declaring stable, competitive bonuses and meeting PRE results in happy and satisfied customers
Such happy customers help build a positive image of the company
This improves persistency and adds to shareholder value
This also helps distributors in convincing prospective policyholders
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19. Estate – Is there an ideal level?
The above discussion leads to a question:
WHAT IS THE IDEAL LEVEL OF ESTATE?
There is no single answer to this. Areas that may be considered include:
Supporting solvency is one of the major uses of estate. Management may use estate to support solvency of non-par business. If this is so, assets will excessively be locked in the par fund. Therefore, estate can be maintained at a level which achieves the solvency target only of the par fund.
Historically, if stable bonus has been maintained then a PRE is created. A higher level of estate needs to be maintained to sustain this PRE.
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Estate – Is there an ideal level?
A high level of estate may imply reduced distribution of surplus. This may suggest a probable unequal distribution across generations of policyholders. To avoid this, any excess estate over that reasonably required needs to be distributed – maybe by way of special bonus.
Higher estate allows greater ability to take risk – increasing risk appetite. The desired level of risk appetite will guide in deciding the ideal level of estate.
Thus, the decision of ideal level of estate is subjective and requires a lot of expertise, experience and judgment of the management especially the Appointed Actuary.
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Thank You,
Any Questions? .
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