2nd younger members’ conference with-profits: how much worse can it get? peter ford 1-2 december...

2nd Younger Members Conference

1-2 December 2003The Glasgow Moat HouseabcdWith-Profits: How Much Worse Can It Get?Peter Ford

Agenda

Bonuses - how much worse can it get?Disclosure - transparency please!Equity Backing Ratio - an anachronistic term?Market Consistency - is this the answer?Waivers and Realistic Reporting - where is consistency?Principles & Practices of Financial Management (PPFM) - ties it all together

Where have we come from...

Source: Lipper Hindsight 90-day moneyacts account, Norwich Union. Past performance based on the product & funds available in January 1991 & is not a guide to the future

Chart1

100009502.84090909099645.95910418710000

1000010738.636363636410110.467380720510627.37

1000010696.022727272710614.508276533611149.62

1000010767.045454545511098.782862706911673.1

1000012180.397727272711632.473222979612112.62

1000013082.386363636412096.981499513112475.42

1000015056.818181818212610.905550146112834.79

1000014332.386363636413065.530671859813180.24

1000014552.556818181813559.68841285313518.95

1000015234.37514043.962999026313899.17

1000016512.784090909116024.54722492714265.12

1000017208.806818181816600.73515092514585.78

1000017649.147727272717220.408958130514879.35

1000019325.284090909117829.211295034115203.58

1000019886.363636363619310.202044790715600.37

1000022073.863636363619969.408471275616026.83

1000022521.306818181822471.82327166516453.51

1000023970.170454545523138.936222005816758.63

1000025255.681818181824822.531645569617060.4

1000025191.761363636425529.177215189917402.16

1000024801.136363636427258.23515092517748.54

1000023451.704545454527952.032619279518094.79

1000022528.409090909125486.679649464518392.25

1000021001.420454545526020.370009737118639.71

1000018899.147727272724087.620253164618886.77

1000019019.886363636424346.163583252219044.13

Original Investment

Managed Fund

With-profits

90 day deposit

Sheet1

GA Investment Bond Past Performance

Following is based upon a 10,000 investment into the With-Profit Fund from 01.01.1991 to

01.07.2002 at 101.5% allocation on an offer to bid basis.

INVESTMENT BOND**

Value atOriginal Investment90-day deposit account*Managed FundWith-Profit Fund - Fund ValueWith-Profit Fund - Surrender Value***

1-Jan-9110,0009502.84090909099645.95910418710000$9,646.00

1-Jul-9110,00010738.636363636410110.467380720510627.37$12,611.00

1-Jan-9210,00010696.022727272710614.508276533611149.62$17,220.00

1-Jul-9210,00010767.045454545511098.782862706911673.1$25,169.00

1-Jan-9310,00012180.397727272711632.473222979612112.62

1-Jul-9310,00013082.386363636412096.981499513112475.42

1-Jan-9410,00015056.818181818212610.905550146112834.79

1-Jul-9410,00014332.386363636413065.530671859813180.24

1-Jan-9510,00014552.556818181813559.68841285313518.95

1-Jul-9510,00015234.37514043.962999026313899.17

1-Jan-9610,00016512.784090909116024.54722492714265.12

1-Jul-9610,00017208.806818181816600.73515092514585.78

1-Jan-9710,00017649.147727272717220.408958130514879.35

1-Jul-9710,00019325.284090909117829.211295034115203.58

1-Jan-9810,00019886.363636363619310.202044790715600.37

1-Jul-9810,00022073.863636363619969.408471275616026.83

1-Jan-9910,00022521.306818181822471.82327166516453.51

1-Jul-9910,00023970.170454545523138.936222005816758.63

1-Jan-0010,00025255.681818181824822.531645569617060.4

1-Jul-0010,00025191.761363636425529.177215189917402.16

1-Jan-0110,00024801.136363636427258.23515092517748.54

1-Jul-0110,00023451.704545454527952.032619279518094.79

1-Jan-0210,00022528.409090909125486.679649464518392.25

1-Jul-0210,00021001.420454545526020.370009737118639.71

1-Jan-0310,00018899.147727272724087.620253164618886.77

30-Apr-0310,00019019.886363636424346.163583252219044.13

Sheet2

Sheet3

Smoothing in action...

Source: Money Management Jan 2003 & Standard & Poors

Bonuses - How much worse can it get?

What has happened to payouts in 2003?25 year Endowments Payouts Year last 2002 2003 at 2003 level % change Highest 113,445 94,954 1988 - 16%Lowest 65,917 57,993 1990 - 12%Average 87,356 71,821 1988 - 18%Source: Money Management - as at 1/2/03Best UK Balance Managed Fund in 2003 - 53,757Regular reviews of payouts throughout the year now commonplaceUnderlying sum assured and annual bonus guarantee biting for many durations

Bonuses - Regular bonuses slashed

Examples: Industry High Low NU No of offices Unitised Pensions 2003 5.35% 1.0% 3.75% 17 2002 5.50% 3.50% 5.25% 18Unitised Life 2003 4.0% 0% 3.25% 17 2002 4.5% 2.0% 4.25% 19Rates falling below minimum guaranteed levelsConventional: Many regular bonuses now passed, NIL or getting pretty close to NIL!Cost of guarantees increasingly onerousSource: NU

What happens next? - Projection assumptions

Historic investment returns:Market median performance

Future Equity Backing Ratio:50% (including 10% property)

Economic Scenarios:

Base ScenarioNo initial change in level of FTSE from 31 Dec 2002Alternative Scenarios:

Scenario 1 Recovery in FTSE to 5,000 in 2003 Scenario 2 Fall in FTSE to 3,000 & 20% property fall in 2003

Copyright Towers Perrin, Forster & Crosby, Inc

What happens next? - Projection assumptions

Followed by:Gilt yield 4.5%Equity return 7.0%

Reversionary Bonus Rates:CWP Life0.5% / 1.5% p.a.UWP Life2.5% p.a.UWP Pensions3.5% p.a.

Sample policy:Regular Premium50 per monthSingle Premium10,000 Copyright Towers Perrin, Forster & Crosby, Inc

Projected asset shares - 25 year endowmentBase scenario



s:\02 financial management\seminars\pn-bonuses MVAs and Gntees Feb 2003

-12%

-20%

-19%

-8%

-8%

-7%

-8%

-6%

-5%

-5%

-5%

-3%

-4%

Maturity Year (at 31 December)

Consultant's Name

Projected asset shares/payouts - 25 year endowmentAlternative investment scenarios




Consultant's Name

Comparison of asset shares and unit funds for regular premium UWP pensions




Issue Year

AS/UF = 96%

AS/UF = 79%

AS/UF = 67%

Consultant's Name

Comparison of asset shares and unit funds for single premium UWP pensions




Issue Year

AS/UF = 132%

AS/UF = 109%

AS/UF = 79%

Consultant's Name

UWP bond with a 10 year no-MVA guarantee2.5% future annual bonus




Guarantee point

Consultant's Name

UWP bond with a 10 year no-MVA guaranteeNo future annual bonuses




Guarantee point

Consultant's Name

Unitised With Profits

Payouts closer to Asset Share for longer durations.Short durations - MVRs will be in place for many years to comeLess smoothing/more active MVR policyNo MVR guarantee dates are valuableUWP bonus rates - new series required for equity - new Smoothed Managed Funds give an opportunityApproach to new business very important - need to be transparent and equitable to new v existing business

Disclosure - transparency please!

Media coverage - could have been worse BUT many companies are failing to be transparentThis damages everyone and the reputation of our professionCommunicate changes in bonuses to policyholders - press releases and updates to company websites Transparent approach required with minimum standardsMedia advertisements may be a good idea

Disclosure - Policy Payout Charter

Press release should includeNew bonus rates and previous rates for conventional and unitised productsPolicy payouts - both savings and mortgage related policiesWith profit bond payoutsWith profit pension payoutsLatest available return on with profit fund, together with details of the returns on the fund over the last five yearsLatest information on asset mix of with profit fundUp to date position on MVRs

Disclosure - Closed Funds

This will become a hot topic!

More information is required of Closed Funds

Are policyholders not entitled to know?

Equity Backing Ratio - an anachronistic term?

What is the appropriate equity backing ratio?

Forced selling of equities to meet statutory solvencyRealistic solvency regime reduces reserving impactFlat markets guarantees biting and close matching needed, further EBR fallsProperty now significant asset class - well understood?Policyholder expectations? - expect a high EBRRisk Based Capital drives further equity reduction?Available capital greatly reducedLots of work to be done in building stochastic models to answer this question!





Current Equity Backing Ratios With profit business, including property, at 31 December 2002

No. of Companies

Consultant's Name





Ratio of yield on 10 year gilt to yield on FTSE 100 at 31 December

Consultant's Name





P/E Ratios on FTSE 100 at 31 December

Consultant's Name

Market consistency - is this the answer?

Market consistent approach to options and guaranteesbuy out or reserve for options and guarantees using market pricing techniquesis there a liquid market?is such an approach reasonable/sound?

Options/guarantees in the money - little or positive impact at/out of the money - substantial impact!Significant extra reserves/capital requirements may resultThe industry does NOT have enough capital!Charges for guarantees may need to be made to asset shares where PRE allows

Market consistency - is this the answer?

Sophisticated models needed to cope with management decision makingDo such models work in practice for real offices?Common economic models need to be developedManagement decisions may need to be complexUntested and untried by most of the industryTime needed to embed these models, test the results and analyse tails of distributionRuntimes are likely to be very challengingWe should NOT rush this process

Waivers and Realistic Reporting - where is consistency?

Realistic reserving MAY lead to lower basic reserves - achieved in short term by Waivers

Interaction with Implicit Items not yet clear?Are waivers as much value as Implicit Items?Lack of consistency in approach to realistic reporting - profession needs to provide this consistency - are we capable of defining realistic? - GAO take up rates? - persistency? Time required to embed new approach. Dangers through too hasty adoption. BUT change was needed!

PPFM - ties it all together

Realistic reporting links directly to PPFM Future bonus policy defined under different conditions under realistic reporting - owned by Board and With Profit Committee Glidepath amount defines degree of smoothing Investment policy defined at different FTSE level reflecting the solvency position of the company Management rules on bonuses and smoothing defined for stochastic modelling This provides a substantially improved discipline for running with profits business in the future

Conclusions

1. Payouts will continue to fall. Annual bonuses reduce to zero.2. MVRs in place for many years to come.3. Disclosure of bonus rates/payouts important.4. Equity Backing Ratios likely to fall further.5. Market consistency - will be very demanding.6. Realistic reporting - a step forward, but NO consistency.7. PPFMs substantially improve disciplines when combined with realistic reporting

abcdWant copies of [email protected]

2nd younger members’ conference with-profits: how much worse can it get? peter ford 1-2 december...

Documents

market consistency

equity backing ratio

anachronistic term

realistic reporting

disclosure transparency

lipper hindsight

product funds available

peter fordagendabonuses