With-profits bonus decision for a closed fund
A UK life insurer's with-profits fund has been closed to new business since 2019. Assets are £1.4bn; supervisory liabilities are £1.25bn; the inherited estate after required capital is £90m. A representative 20-year endowment policy has an asset share of £82,000, guaranteed benefits of £76,500 and a current final bonus of £3,000. The fund returned 7.8% gross (7.2% net) last year; the 10-year gilt yield is 4.1% and CPI is 3.2%. Surrenders are running 6% above expected as households face cost-of-living pressure. The with-profits committee is considering raising annual bonuses by 0.5% of guaranteed benefits and final bonuses to 6% of asset share, while distributing 25% of the estate over five years. Some policies have mortgage repayment guarantees. The board wants a recommendation that is fair, affordable and consistent with the PPFM.
1. Assess whether the proposed bonus increases and estate distribution are affordable and fair. Support your answer with calculations and identify the main conflicts between policyholder groups.
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Current payout: guaranteed benefits £76,500 plus final bonus £3,000 = £79,500, or 97.0% of the £82,000 asset share. Proposed payout: annual bonus increases guaranteed benefits by 0.5% x £76,500 = £382.5 to £76,882.5. Final bonus at 6% of asset share is £4,920. Total payout becomes £81,802.5, or 99.8% of asset share. This is close to full asset share and leaves almost no smoothing margin for this cohort.
The estate is not free capital. Distributing 25% of £90m means £22.5m, or £4.5m a year. At 7.2%, the estate earns roughly £6.5m a year, but it also absorbs guarantee costs and smoothing. After five years the estate would be £67.5m before returns and guarantee costs, so the plan is affordable only if returns hold and guarantee costs are low. The mortgage repayment guarantees and the closed fund mean the estate must support policyholder reasonable expectations, not just current payouts.
Fairness conflicts exist. Paying near asset share to exiting policyholders reduces lapse anti-selection but transfers estate to one cohort. Continuing policyholders and guaranteed policies bear the risk if returns disappoint. A phased increase is preferable: for example, final bonus to 5% and annual bonus to 0.25%, retaining at least £75m of estate, with a quarterly review against asset shares, gilt yields and surrender experience.
2. Recommend how the firm should govern and communicate the decision, and how it should monitor outcomes after implementation.
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The decision should go through the with-profits committee with documented Treating Customers Fairly analysis and independent challenge. The firm should map the proposal against the PPFM, explain how the estate is being used and why the payout ratio is appropriate, and record the conflicts between exiting and continuing policyholders.
Communication should be plain and specific: show the current and proposed payout against asset share, explain that bonuses are not guaranteed, and warn that future final bonuses may be reduced if investment returns or expenses deteriorate. Surrender values should be reviewed to avoid a two-tier outcome.
Monitoring should cover payout ratios by cohort, surrender and lapse rates against expected, estate level, guarantee costs, investment return versus assumed, and gilt yields. Stress tests should include a 5% fall in asset values, a 50% rise in surrenders and a 100bp fall in gilt yields. Material outcomes should be reported to the board and, where required, the regulator.