'With profit' products are sold by life insurance companies either as endowment assurance or whole-of-life plans. These are traditional (vis-a-vis unit-linked) products and are at heart, long-term savings plans. An endowment assurance policy is the most popular form of such a product. Even though primarily a savings vehicle, it provides valuable life insurance protection if the insured person dies during the term of the policy.
Insurance products that have savings components built into them generally provide a range of risk-reward option to the prospective policy-holders. Ulips form one end of the spectrum where the policyholder bears the entire investment risk. The non-participating policies provide fixed benefits and the policyholder does not share in any investment risk. The participating policies fall in the middle and the investment risk and return are shared by the policyholders and the company.
Basic sum assured guarantee
Under a typical endowment product, the basic guarantee provided is known as the sum assured. It is the amount available in return for the premiums payable, at maturity or earlier death. The sum assured generally carries a prudent guaranteed return on the premiums paid and forms the basic guaranteed benefit around which the other benefits are built.
At the end of each year, based on the experience to date and also the outlook for the future performance, further amounts in the form of annual bonus may be credited as a percentage of the basic sum assured or as a percentage of the sum assured plus bonuses already declared. These bonuses are called simple reversionary or compound reversionary bonuse respectively.
The requirement of the smoothing of bonuses (policyholders would not expect these to vary wildly from year to year) would mean that the bonus would be such that it would not be too different from the previous year's bonus. It would also be such that it can be sustained based on the expected future experience. This is because firstly, the regular bonuses once declared are guaranteed and add to the basic sum assured and secondly, the bonus for the year cannot reduce too rapidly even if the performance is unfavourable for that year.
The surplus that arises in the year is largely due to higher investment return earned than underlying the basic guarantee, but there are other components of the surplus such as mortality and expense experience. While the company would have its internal norm or policy regards the level of the long term regular bonus and when and how sharply to increase/reduce bonus rates, there would understandably be some commercial considerations to keep the rates above those of competitors.
Whatever the level of regular bonuses credited during the term of the policy, for customers to be treated fairly, they would need to be paid back something close to the returns that are earned over the term during which he was invested. This is achieved through the terminal bonus that provides the balance. There are complex models known as 'asset share' models using which actuaries track the actual performance of the policyholders funds and decide on the level of terminal bonus so as to be roughly equitable to the policyholder.
The traditional participating structure is not meant to be perfectly equitable to all classes and generations of policyholders. The total payouts at maturity are decided in such a manner that on similar plans they do not vary greatly from year to year. This introduces a level of in-equity between generations of policyholders. The funds belonging to the various products are pooled together. Allocation of investment returns and expenses are done on an aggregate basis. Such pooling to a certain extent may be inequitable to the different groups of policies/policyholders.
Nature of participation
A statutory valuation of the assets and liabilities of the long term participating fund is carried out by the appointed actuary of the life insurance company in accordance with the Irda Asset Liability and Solvency Margin Regulation 2000. According to the Irda Distribution of Surplus Regulation 2002, of surplus arising, 90% is allocated to the policyholders in the form of bonus and the rest is transferred to the shareholders.
Future of with-profit products:
Participating products over the years have been the mainstay of the products sold by LIC , resulting in a huge build up of the 'with profits' fund. Since the opening up of the industry to private players and the advent of Ulips, customers have found the transparency of returns and charges afforded by Ulips more attractive.
However, for the risk averse customer looking for a stable long term but real return, the participating product is still a good vehicle to invest in. Less opacity, greater transparency by way of disclosure regarding the manner in which the company conducts it with profits business would protect the interest of the policyholder and promote confidence.
By Sanjeev Pujari, Chief Actuary SBI Life Insurance