Surrender values and bonus declaration in a with-profits cohort
A mutual life insurer's with-profits fund holds assets of ₹4,200 crore against a realistic policyholder liability of ₹4,050 crore. For a cohort of 42,000 twenty-year endowment policies written in 2009, the asset share is ₹3.6 lakh per policy, while the guaranteed sum assured plus declared vested bonuses is ₹4.1 lakh. Surrenders in this cohort have risen to 14% per annum from 6% historically. The current surrender value is 78% of the guaranteed amount. The fund's investment return has fallen from 8.4% to 6.7% over three years, and the regulator has asked whether the declared reversionary bonus of ₹45 per ₹1,000 sum assured is supportable. The board is considering declaring either a terminal bonus or a special surrender value. The 90:10 sharing rule applies, and the insurer's actual shareholder transfer has recently run at 12.5% of surplus.
1. Assess the cohort's financial position and whether a 14% surrender rate is rational. Recommend a surrender value policy.
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Position. Guaranteed liabilities for the cohort are 42,000 × ₹4.1 lakh = ₹1,722 crore; asset share is 42,000 × ₹3.6 lakh = ₹1,512 crore. The cohort is underfunded by ₹210 crore, or 12.2% of the guarantee, and the deficiency sits with the fund and ultimately the shareholder. The surrender value of 78% × ₹4.1 lakh = ₹3.198 lakh is below asset share, so each surrender actually transfers about ₹40,000 to the continuing policyholders. At 14%, about 5,880 policies surrender, paying ₹188 crore against an asset share of ₹212 crore - a ₹24 crore gain to the fund, but a serious fairness and conduct question.
Is 14% rational? Financially, no: a policyholder with a guarantee 12% above asset share and a fund earning 6.7% should hold. The rate is therefore likely driven by liquidity needs, mis-selling, or competitor headline rates. Because the guarantee is now in the money, further rises in the surrender rate would be adverse if the insurer responded by paying more.
Recommendation. Keep the surrender value below asset share, but publish a clear, consistently applied basis and explain the guarantee. Do not introduce a special surrender value that rewards exit. If market value reductions are used, publish the scale in advance. Test the conduct risk that policyholders were sold the plan as a savings deposit, and check that the 78% level meets the regulator's minimum guaranteed surrender value requirements. Monitor the cohort monthly; if surrenders exceed 18%, investigate whether the distribution channel is churning.
2. Is the ₹45 per ₹1,000 reversionary bonus supportable? Recommend a declaration and address the 90:10 issue.
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Affordability. ₹45 per ₹1,000 is 4.5% of sum assured. On a representative ₹2 lakh sum assured the bonus is ₹9,000, which adds directly to the guaranteed amount and therefore to the cost of the guarantee. Net of about 0.8% expenses, tax and 0.2% investment costs, the fund is earning roughly 5.0–5.3% on asset share. Asset share would grow from ₹3.6 lakh to about ₹3.79 lakh (+₹19,000), while the guarantee grows by ₹9,000. The ratio improves marginally, but from a position where the guarantee already exceeds asset share, so the fund has almost no cushion if yields fall another 100 bp.
Recommendation. Declare a lower reversionary bonus, perhaps ₹25–30 per ₹1,000, and use a terminal bonus as the non-guaranteed mechanism to distribute emerging surplus. Reversionary bonus is irrevocable and compounds the guarantee; terminal bonus preserves flexibility and allows equity between cohorts. Support the recommendation with a stochastic projection of the cost of the guarantee at the 5th percentile of returns and a comparison of the cohort's guarantee-to-asset-share ratio against other cohorts.
90:10. A 12.5% shareholder transfer exceeds the 10% permitted under the sharing rule. Unless the excess is attributable to identifiable charges (expense charges, cost of guarantee, or a properly documented shareholder charge), it is a breach and should be corrected, with the 2.5% excess and interest returned to the fund. Quantify the cumulative over-transfer and disclose it to the board and the regulator. The correction will reduce the shareholder's reported surplus and should be reflected in the bonus decision.
3. What should the insurer tell the regulator, and what governance steps should accompany the bonus decision?
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Communication. The insurer should respond factually: the cohort's asset share versus guarantee, the surplus position of the fund, the basis for the bonus rate, a sensitivity showing the effect of a 100 bp fall in yields, and the corrective plan for the 90:10 breach. It should not present the higher bonus as evidence of strength. If the realistic liability is understated, the response should say so and give a timeline for correction.
Governance. The bonus decision should be made by the board on the Appointed Actuary's advice, with the with-profits committee or its equivalent documenting:
- the principles and practices of financial management, including how the cost of the guarantee and expenses are charged;
- cohort-by-cohort equity analysis, so that one generation is not subsidising another;
- the treatment of surrenders and the surrender value basis;
- the shareholder transfer calculation and the correction of the excess.
The Appointed Actuary's report should state the sensitivity of the fund to a further fall in yields and to a rise in surrenders, and should confirm that the declaration is consistent with policyholder reasonable expectations.
Follow-up. Set triggers - for example, if the fund's free asset ratio falls below a stated level or the guarantee-to-asset-share ratio exceeds 110%, the bonus rate is reviewed automatically. Report to the regulator quarterly until the 90:10 correction is complete, and rectify any customer communication that described the plan as a guaranteed deposit.