Participating fund bonus decision under a falling yield environment
Sunrise Life's participating fund holds ₹8,200 crore of assets: 62% in government securities with a book yield of 7.1% and an average duration of 9.4 years, 24% in equities and 14% in AA corporate bonds. Over the last 18 months the 10-year G-sec yield has fallen from 7.6% to 6.5%, while the fund's liabilities have a duration of about 14 years. The insurer has declared a reversionary bonus of 4.2% of sum assured for ten consecutive years, and the sales force routinely shows illustrations implying an 8% IRR at maturity. The estate stands at ₹310 crore against an internal target of 5% of the fund. The regulator requires at least 90% of surplus to be allocated to policyholders. New business volumes in the participating line have fallen 30% year on year, and the CFO wants the bonus maintained to protect sales. The appointed actuary must recommend a bonus rate at the next board meeting.
1. Set out the analysis you would perform before recommending a reversionary bonus rate, including how you would treat the estate and the 90:10 surplus distribution rule.
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Bonus must be financed out of surplus emerging on asset shares, not out of the estate and not out of an assumed recovery in yields.
1. Roll forward asset shares by cohort. Allocate premiums, expenses, mortality and lapse costs, investment return and the existing 4.2% bonus on a realistic basis. The 7.1% book yield persists only while the 9.4-year assets are held; with a 14-year liability duration, maturing assets will be reinvested at 6.5% or lower. I must model the yield path, not today's rate.
2. Test sustainability. Project supportable bonus under reinvestment of 6.5%, 6.0% and 5.5%, with equity returns of 8% and a 15% fall in the first two years. A rate is only prudent if it is expected to be maintainable until the next review without relying on the estate.
3. Apply the 90:10 rule cohort by cohort. Confirm whether ₹310 crore exceeds the 5% target. Any excess over target belongs to policyholders and can support a distribution or a one-off uplift, but using it to sustain an unaffordable rate transfers money from long-stay policyholders to those who surrender early.
4. Form the recommendation on the central scenario, with a documented fallback and a trigger for early review. If the 6.0% scenario cannot support 4.2%, I would recommend a staged reduction (for example to 3.6% now with a review at 12 months) rather than a cliff-edge cut.
2. The CFO argues that any reduction will trigger complaints and mis-selling claims. How should you weigh policyholder reasonable expectations against long-term solvency, and what would you put to the board?
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The two arguments are being conflated, and the board paper should separate them.
PRE is not a guarantee. Reasonable expectations require consistency of treatment and the absence of arbitrary change; they do not require a rate that the fund cannot finance. A reduction that tracks a genuine, evidenced fall in investment return is consistent with PRE. Paying 4.2% by drawing down the estate is not: it postpones the correction, leaves the fund weaker for policyholders who remain, and creates a larger expectation for next year.
The mis-selling risk arises elsewhere. The 8% IRR illustrations and distributor statements are a conduct issue that exists independently of the bonus decision. A risk is that continuing to declare 4.2% validates those illustrations and makes the eventual correction worse. I would recommend a review of illustration assumptions and distributor scripts as part of the same board paper.
Board paper content: three bonus scenarios, each showing cost, projected estate, projected solvency position, expected lapse and complaint volumes, and the effect on new business strain. I would state my recommendation, the reasoning, and the conditions under which I would revisit it.
If the board decides otherwise, I record my advice in the minutes, document that the decision is within the board's authority, and consider whether the outcome threatens the interests of policyholders sufficiently to require escalation.
3. The sales team proposes a new 12-year participating endowment with a first-year bonus of 4.5%. Advise on the actuarial and regulatory issues this raises.
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A new product cannot inherit the in-force bonus rate by default.
1. Asset share at outset. On current yields, expenses and a 12-year horizon, project the asset share the new cohort can expect to accumulate. Setting a first-year bonus of 4.5% creates a liability from day one that must be met from that cohort's own future surplus; funding it from the estate or from existing policyholders is a cross-subsidy and would be difficult to defend to either group.
2. New business strain. Compute the strain at point of sale under realistic assumptions and check it against available capital and the strain the insurer can absorb given falling volumes and the current estate position.
3. Illustration consistency. Illustrations must reflect realistic returns and the declared bonus basis; showing 8% IRR alongside a 4.5% first-year bonus compounds the existing mis-selling exposure identified in the in-force book.
4. Regulatory filing. The product must be filed under the applicable product regulations, with the actuarial assumptions, the bonus philosophy and the surrender basis documented; I would need to be satisfied that the design, charges and benefit illustrations meet the policyholder-protection requirements before signing the filing.
Recommendation: do not launch at a 4.5% first-year bonus unless the 12-year asset share projection supports it on the 6.0% reinvestment scenario; otherwise design a lower initial bonus with a credible step-up path.