abcd
2nd Younger Members’ Conference
With-Profits:
How Much Worse Can It Get?
1-2 December 2003
The Glasgow Moat House
Peter Ford
Agenda
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
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
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
£0
Jan-91
Apr-91
Jul-91
Oct-91
Jan-92
Apr-92
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Jan-93
Apr-93
Jul-93
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Apr-00
Jul-00
Oct-00
Jan-01
Apr-01
Jul-01
Oct-01
Jan-02
Apr-02
Jul-02
Oct-02
Jan-03
Apr-03
Where have we come from...
£30,000
With-profits
£25,000
Managed Fund
£20,000
£15,000
90 day deposit
Original Investment
£10,000
£5,000
Source: Lipper Hindsight 90-day money£acts account,
Norwich Union. Past performance based on the product &
funds available in January 1991 & is not a guide to the future
Smoothing in action...
35
35
25
25
15
15
5
5
-5
-5
-15
-15
-25
-25
Au
g19
Fe 90
b19
Au 91
g19
Fe 91
b19
Au 92
g19
Fe 92
b19
Au 93
g19
Fe 93
b19
Au 94
g19
Fe 94
b19
Au 95
g19
Fe 95
b19
Au 96
g19
Fe 96
b19
Au 97
g19
Fe 97
b19
Au 98
g19
Fe 98
b19
Au 99
g19
Fe 99
b20
Au 00
g20
Fe 00
b20
Au 01
g20
Fe 01
b20
Au 02
g20
Fe 02
b20
03
Annualised rate of return (% p.a.)
Comparison of with profits policies and UK equity unit trusts:
£50 p.m. regular investment 10 year investment period
Date of taking proceeds
UK Equity Unit Trusts
With Profits
With Profit median
UK Equity Median
Source: Money Management Jan 2003 & Standard & Poors
Bonuses - How much worse can it get?
 What has happened to payouts in 2003?
2002
25 year Endowments Payouts
Year last
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 1/2/03
Best UK Balance Managed Fund in 2003 - £53,757
Regular reviews of payouts throughout the year now commonplace
Underlying sum assured and annual bonus guarantee biting for
many durations
Bonuses - Regular bonuses slashed
 Examples:
Industry
Unitised Pensions
Unitised Life
High
Low
NU
No of offices
2003
5.35%
1.0%
3.75%
17
2002
5.50%
3.50%
5.25%
18
2003
4.0%
0%
3.25%
17
2002
4.5%
2.0%
4.25%
19
Rates falling below minimum guaranteed levels
Conventional: Many regular bonuses now passed, NIL or getting pretty
close to NIL!
Cost of guarantees increasingly onerous
Source: NU
What happens next?
- Projection assumptions
Historic investment returns:
Market median performance
Future Equity Backing Ratio:
50% (including 10% property)
Economic Scenarios:
Base Scenario
No initial change in level
of FTSE from 31 Dec 2002
Alternative Scenarios:
Scenario 1
Scenario 2
© Copyright Towers Perrin, Forster & Crosby, Inc
Recovery in FTSE to 5,000
in 2003
Fall in FTSE to 3,000 &
20% property fall in 2003
What happens next?
- Projection assumptions
Followed by:
Gilt yield
Equity return
4.5%
7.0%
Reversionary Bonus Rates:
CWP Life
UWP Life
UWP Pensions
0.5% / 1.5% p.a.
2.5% p.a.
3.5% p.a.
Sample policy:
Regular Premium
Single Premium
£50 per month
£10,000
© Copyright Towers Perrin, Forster & Crosby, Inc
Projected asset shares - 25 year endowment
Base scenario
100,000
-1 2%
-2 0%
-1 9%
50,000
-8 %
-8 % -7 %
-8 %
-6 % -5 %
-5 % -5 % -3 % -4 %
0
1999
2000
2001
2002
2003
2004
2005
2006
2007
Maturi ty Year (at 31 Decembe r)
Copyright Towers Perrin, Forster & Crosby, Inc
2008
2009
2010
2011
2012
Projected asset shares/payouts - 25 year endowment
Alternative investment scenarios
70,000
60,000
50,000
40,000
30,000
20,000
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Asset Shares (FTSE starts at 4,000)
Payouts (FTSE starts at 5,000)
Copyright Towers Perrin, Forster & Crosby, Inc
Payouts (FTSE starts at 4,000)
Payouts (FTSE starts at 3,000)
Comparison of asset shares and unit funds for regular
premium UWP pensions
15,000
AS/UF = 96%
10,000
AS/UF = 79%
5,000
AS/UF = 67%
0
1988
1993
Asset Share at 31/ 12/02
Copyright Towers Perrin, Forster & Crosby, Inc
1998
Unit F und at 31/ 12/02
Issue Year
Comparison of asset shares and unit funds for single
premium UWP pensions
40,000
AS/UF = 132%
30,000
AS/UF = 109%
20,000
AS/UF = 79%
10,000
0
1988
1993
Asset Share at 31/12/02
Copyright Towers Perrin, Forster & Crosby, Inc
1998
Issu e Year
Unit Fund at 31/12/02
UWP bond with a 10 year no-MVA guarantee
2.5% future annual bonus
20,000
10,000
0
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Guarantee point
Asset Share
© Copyright Towers Perrin, Forster & Crosby, Inc
Unit Fund
UWP bond with a 10 year no-MVA guarantee
No future annual bonuses
20,0 00
10,0 00
0
2002
2003
2004
2005
2006
2007
Asset Share
© Copyright Towers Perrin, Forster & Crosby, Inc
2008
2009
Unit Fund
2010
2011
2012
Guarantee point
Unitised With Profits
 Payouts closer to Asset Share for longer durations.
 Short durations - MVRs will be in place for many years
to come
 Less smoothing/more active MVR policy
 No MVR guarantee dates are valuable
 UWP bonus rates - new series required for equity
- new Smoothed Managed Funds
give an opportunity
 Approach 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 transparent
 This damages everyone and the reputation of our
profession
 Communicate changes in bonuses to policyholders press releases and updates to company websites
 Transparent approach required with minimum standards
 Media advertisements may be a good idea
Disclosure - Policy Payout Charter
 Press release should include
 New bonus rates and previous rates for conventional and
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unitised products
Policy payouts - both savings and mortgage related policies
With profit bond payouts
With profit pension payouts
Latest available return on with profit fund, together with
details of the returns on the fund over the last five years
Latest information on asset mix of with profit fund
Up 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 solvency
 Realistic solvency regime reduces reserving impact
 Flat markets  guarantees biting and close matching
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needed, further EBR falls
Property now significant asset class - well understood?
Policyholder expectations? - expect a high EBR
Risk Based Capital drives further equity reduction?
Available capital greatly reduced
 Lots of work to be done in building stochastic
models to answer this question!
Equity Backing Ratio - an anachronistic
term?
Current Equity Backing Ratios
With profit business, including property, at 31 December 2002
No. of Companies
10
5
0
Low (25%-35%)
© Copyright Towers Perrin, Forster & Crosby, Inc
Medium (35%-55%)
High (>55%)
Equity Backing Ratio - an anachronistic
term?
Ratio of yield on 10 year gilt to yield on FTSE 100 at 31
December
3.5
3.0
2.5
2.0
1.5
1.0
1967
© Copyright Towers Perrin, Forster & Crosby, Inc
1997
Equity Backing Ratio - an anachronistic
term?
P/E Ratios on FTSE 100 at 31 December
35.0
30.0
25.0
20.0
15.0
10.0
5.0
0.0
1993
1994
© Copyright Towers Perrin, Forster & Crosby, Inc
1995
1996
1997
1998
1999
2000
2001
2002
Market consistency - is this the answer?
 Market consistent approach to options and guarantees
 “buy out” or reserve for options and guarantees using market
pricing techniques
 is 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 result
 The 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 making
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
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Do such models work in practice for real offices?
Common economic models need to be developed
Management decisions may need to be complex
Untested and untried by most of the industry
 Time needed to embed these models, test the results
and analyse tails of distribution
 Runtimes are likely to be very challenging
 We 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.
2.
3.
4.
5.
6.
7.
Payouts will continue to fall. Annual bonuses
reduce to zero.
MVRs in place for many years to come.
Disclosure of bonus rates/payouts important.
Equity Backing Ratios likely to fall further.
“Market consistency” - will be very demanding.
Realistic reporting - a step forward, but NO
consistency.
PPFMs substantially improve disciplines when
combined with realistic reporting
abcd
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