Question 2

a)

MoS methodology for calculating the policy liabilities for participating business and how it differs from non-
participating business:

 Policy liability at the end of the year is calculated as:

the Value of Supporting Assets (VSA)
- the cost of current year best estimate bonus (for policies still in-force)
- shareholder profit margin on that bonus
 The deductions ensure that the cost of current year best estimate bonus and associated shareholder
profit margin emerge as profit in the current year
 The VSA at reporting date is calculated as:
the policy liability at end of previous reporting period
+ the cost of declared bonuses at the end of previous reporting period
+ actual policy related cash flows and investment experience
- policyholder profits emerging on exiting policies during the year (policyholder interim reversionary
bonuses and terminal bonuses at the supportable bonus rate)
- shareholder profits emerging on exiting policies during the year (shareholder share of interim
reversionary bonuses and terminal bonuses at the supportable bonus rate)
- non-investment experience profit
 The VSA sets the liability equal to the value of the assets backing it, after removing the planned
shareholder profit and non-investment experience profit. This ensures that all investment profits/losses in
any year are offset by corresponding changes in the policy liability
 supportable bonus is determined such that the present value of outflows less present value of inflows plus
present value of bonuses and profits is equal to the value of supporting assets
 interim bonuses are deducted from the policy liability because they are a distribution of profit, not an
allocation of it
 unlike non-participating business, actual investment experience is retained within the policy liability
instead of being allowed to emerge as an experience profit
 the discount rate used will be the expected investment earnings rate on the assets backing the policy
liabilities which is different to non-participating business where either the risk-free rate or the expected
investment earnings rate may be used

Other differences from non-participating business:

 discount rate is based on the expected return of the underlying assets, while for non-participating the
discount rate is risk-free
 economic assumption changes are not released through profit, whereas for non-participating business
they are

b)

Shareholder Profit
= 20% x Total Profit for the Participating Portfolio
= 20% x 4,800,000
=960,000
Policyholder (P/H) Retained Earnings (end of 2015)
= Policyholder (P/H) Retained Earnings (beginning of 2015)
+ 80% x Total Profit for the Participating Portfolio
- Cost of declared bonus
- Interim and Terminal bonus paid
+ Interest earned on P/H retained earnings (2015)
= 50,250,000
+ 80% x 4,800,000
- 3,300,000
-0
+ 2,010,000
= 52,800,000

Shareholder Retained Earnings (end of 2015)

= 25 % x P/H Retained Earnings (end of 2015)
= 25% x 52,800,000
= 13,200,000

c)

To: CFO
Subject: Ways to Reduce the Risk of a Tontine
From: Actuary

Thank you for your suggestions on how Trigger Life can attempt to reduce the risk of a tontine occurring. There are
some good ideas, but not all of them are ideal. Please see below on my thoughts on your ideas.

Distributing excess policy owners' retained earnings to shareholders

 the Life Act only allows policy owners' retained earnings to be distributed to participating policy owners – not
legal

Making a one-off declaration now, and increasing future bonus declarations

 Making a one-off declaration would reduce future policy owners' retained earnings by the cost of the declared
bonuses and increase policy liabilities
 The policy liability will increase, but probably by less than the cost of the declared bonuses because the
surrender value basis will be more conservative than the policy liability basis
 MoS profit will not be impacted because the bonus declaration is only a distribution of profit from policy owner
retained earnings
 This is not a bad idea, where the advantages of this approach include:
 it allows Trigger Life to reward existing P/H who have contributed to the build up in surplus over time.
 It also allows the company to ensure a degree of smoothness in returns to continue to meet the reasonable
expectations of policyholders
 Although, there are also disadvantages such as:
  reversionary bonuses once declared are guaranteed which will lead to an increase in the company's capital
requirements to support the guaranteed nature of reversionary bonuses
 reduces the amount of retained earnings in the fund which reduces the capacity of the fund to withstand
future volatility in asset values
 A better version of this approach is to use a one-off terminal bonus. This is more appropriate because it would
have less of an impact on P/H expectations since they are typically promoted as non-guaranteed and can be
removed/reduced anytime. It also requires less capital to support since they are non-guaranteed and are only
distributed to owners of terminating policies

Purchasing a participating book from another life insurer

 Key considerations
 the impact on the benefit expectations of the P/H of each book of participating business. This can be
considered in terms of minimum contractual benefits and the bonus policy for the combined business
 the steps required as a part of the merger to secure the P/H reasonable expectations if there are different
expectations for different groups or cohorts within the two books
 equity between the two groups of P/H where it would not be appropriate to use the large amount of P/H
retained earnings of Trigger Life P/H reward P/H of the purchased book
 the likelihood and potential effects of shock lapses as P/H may become dissatisfied with the merger
 the impact on the security of the benefits of the P/H of each life company. This can be evaluated in terms
of net assets and capital positions
 adjustments to be made to the existing expense allocation for each book and how it would impact benefit
expectations
 treatment of costs associated with a merger, i.e will P/H or S/H bear the costs
 treatment of any cost synergies
 adoption of investment policy for merged book and the impact on P/H benefits
 administrative and system issues with administering the policies of the acquired book
 bonus structure of each portfolio - if they are very different it will be difficult to merge the two portlios
together under one bonus structure since the terms and conditions of the policies are unlikely to allow
significant changes to the bonus structure
 mortality experience of the two books - level of similarity. Need to consider fair treatment of mortality
profits. This will also affect the future bonuses emerging, if there is cross-subsidisation
 It would only be appropriate to use one bonus series if it meets the P/H expectations of both groups of policies,
i.e. bonus rates cannot be lower than what they were receiving prior to the merger
 In addition, it is suggested that P/H retained earnings of each book is ring fenced and only be used for the
books of P/Hs that contributed to them

Funding the Growth in the Open Life Insurance Business using P/H Retained Earnings
 Not possible due to products being in different stat. funds

Other issues:
 If Trigger wasn’t open to purchasing a participating book from another life insurer or re-opening the
participating book to new business, then making a one-off bonus declaration and increasing future bonus
declarations would be the only realistic option to prevent a tontine. However the size of the one-off
declaration needs to be careful consideration – too small and the tontine problem may re-emerge in the near
future, too large and the profit distribution may turn out to be inequitable in the long term if experience
deteriorates (as policyholders who have terminated will have taken more than their fair share).
  System upgrades and staff training would be required when purchasing a participating book of business from
another insurer, since the products may have slightly different features. Trigger Life’s administration system
may not be able to administer all policies and an upgrade may be required.
 The impact of any proposal on the capital requirements needs to be considered. Trigger needs to maintain an
appropriate level of capital at all times, with some methods of distributing the policy owners’ retained
earnings having a greater capital burden than others.
 The retained earnings can distributed via terminal bonus instead. This would be relatively easy to administer,
and the terminal bonus amount can be varied depending on investment experience. This can be structured as
a percentage of the policyholder’s asset share (which is the premiums less expenses and claims accumulated
with actual investment returns). There is also lower capital requirements associated with this method as
compared to declaring a higher reversionary bonus.

Yours Sincerely,

Actuary