Participating fund bonus decision under solvency and liquidity strain
A mid-sized life insurer's participating fund holds a legacy block of 20-year endowment policies. For the cohort maturing next quarter, the asset share is 96% of the sum assured plus declared bonuses, while the fund's smoothed book value is 104% of the same cohort's policy liabilities. Ten-year government bond yields have fallen 150 basis points in nine months and the fund's bond portfolio duration is 11 years against a liability duration of 7 years. Surrenders are running 30% above the pricing assumption and new business volumes have collapsed. The fund's solvency coverage is 1.45 times the regulatory minimum, below the board's 1.60 internal target. The chief executive wants to declare a special terminal bonus of 8% to improve maturing policyholders' payouts and stem adverse press coverage. The appointed actuary must advise the board tomorrow. The fund has no external capital support and shareholders are unwilling to inject cash.
1. Assess whether the proposed 8% special terminal bonus is consistent with prudent management of the participating fund. Show the figures you would compare and the risks you would weigh.
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The starting point is the asset share, not the smoothed book value. The cohort has earned 96% of sum assured plus declared bonuses. An 8% special terminal bonus would take the payout to roughly 104% on the same base, which is about 8 percentage points above the asset share. That excess must be funded by other cohorts, by the inherited estate, or by shareholders. There is no shareholder support, so the practical source is other policyholders.
The 104% smoothed book value does not prove affordability. It may include unrealised gains and smoothing reserves, and the duration mismatch of 11 years against 7 years means the recent 150 basis point fall in yields has flattered asset values relative to liabilities. If yields revert, the fund's coverage can fall quickly. Paying a special bonus now locks in a transfer at a potentially temporary valuation.
Solvency is 1.45 times the minimum against a 1.60 target, so the fund is already about 9% below its internal target. A special bonus reduces capital at the same time as surrenders are 30% above assumption and new business has collapsed. That combination creates liquidity risk: the fund may have to sell long-dated bonds at depressed yields to meet cash outflows.
My advice would be not to approve the 8% bonus as proposed. A smaller discretionary increase could be considered only if a stressed asset share still supports it, solvency remains above 1.60 after the payment, and the liquidity buffer is adequate. The board should also consider intergenerational fairness and treating customers fairly, because continuing policyholders would bear the cost.
2. Draft the key messages you would give the board, including the conditions under which any discretionary increase could be paid.
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The board needs a short, decision-focused message:
- The asset share for the maturing cohort is 96%, so an 8% special bonus is not affordable from that cohort's own assets. It would be a cross-subsidy.
- The 104% smoothed value is not a cash surplus and is sensitive to the duration mismatch. A reversal in yields would weaken solvency further.
- Solvency is already below the internal target and the fund has no shareholder support. The proposed bonus would make the position worse.
- Surrender activity and weak new business create liquidity pressure. Cash leaving the fund is more expensive than accounting losses.
Conditions for any discretionary increase:
- The increase must be supportable by the cohort's asset share after a stress test, including a rise in yields and a persistency shock.
- Post-payment solvency must stay above the 1.60 internal target, with a documented buffer for further deterioration.
- The fund must hold enough liquid assets to meet three months of stressed surrenders and maturities without forced sales of long-dated bonds.
- The payment must be consistent with the fund's smoothing policy and disclosed as discretionary, not guaranteed.
- The board should minute the reasoning and consider whether the regulator needs early notification.
I would recommend communicating a clear decision rather than a vague promise. If a smaller bonus is paid, the board should explain that it is discretionary and conditional on the fund's overall position.
3. Explain how you would communicate the decision to policyholders and distributors without creating mis-selling or conduct risk.
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The communication should be plain, consistent and honest about discretion. Policyholders should be told what has been decided, how the payout compares with the policy's asset share, and that future bonuses are not guaranteed. Avoid phrases such as 'the fund can afford it' or comparisons with competitors. If the special bonus is reduced or not paid, explain that the fund's assets must support all policyholders and that current market conditions have affected the fund.
For distributors, provide a short Q&A with approved wording. Emphasise that terminal bonuses are discretionary, that past bonus rates are not a guide, and that they must not imply a guarantee or encourage replacement business. Call-centre scripts should be tested for clarity and should direct complex cases to a specialist team. Record the basis of the decision and keep a log of complaints and queries.
If the board pays a smaller bonus, communicate the conditions: it is supported by the cohort's asset share, it preserves the fund's solvency target and it is reviewed at the next valuation. If the board pays nothing, explain the trade-off without blaming a single group of policyholders. The tone should be factual, not defensive. The aim is to preserve trust while avoiding a reasonable expectation of future discretionary payments.