Par policies could yield lower bonuses with new risk-based capital framework

Singapore

LIFE insurance policyholders of participating (par) products can expect bonus restructuring, a cut in bonus rates or a combination of both, under the proposed changes to the existing risk-based capital framework (RBC 2), according to industry observers.

RBC 2, which is still in the works, seeks to reflect the relevant risks that insurers face. But, as reported in The Business Times last October, it is expected to substantially raise life insurers' overall capital charges due to the leap in equity charges and credit risk charges.

Even if an insurer's par fund has enough assets to meet projected policy obligations, high capital charges lock up funds and curtail its ability to allocate bonuses to policyholders.

To mitigate the squeeze on their finances, life insurers could either restructure par policy bonuses or move to cut bonus rates, observers said.

Bonus restructuring, similar to that executed by NTUC Income in 2008, involves reducing future reversionary bonus and increasing future terminal bonus to maintain a similar payout, a source familiar with actuarial work explained.

Once allocated to policyholders, reversionary bonus - an annual bonus that cannot be reduced once added - raises the policy's guaranteed benefits, which in turn drive up the insurer's capital charges. In contrast, terminal bonus - allocated to policyholders only when they surrender their policies, make claims, or when the policies mature - do not lock in guarantees and capital charges in advance.

RBC 2 may also force life insurers to minimise their capital charges by reducing their allocations to equities and invest in government bonds instead. Existing bonus projections may no longer be supportable under the low investment return from such defensive asset allocation, causing bonuses to be cut, said the source.

Yeo Keng Leong, a lecturer at Nanyang Business School, thinks terminal bonus (which is a more flexible component in insurers' calculations) would more likely be cut as the effects of cutting reversionary bonuses "take more time to be felt".

"Cutting terminal bonuses will have a more immediate impact that can help offset the sudden increase in capital due to RBC 2," said Dr Yeo.

Philip Chung, Standard & Poor's credit analyst, said it is likely that life insurers will change bonus allocations, including interim bonuses, terminal bonuses and cash bonuses.

Another possible development, said Dr Yeo, is that life insurers could stop sales of their current series of whole life policies and endowment plans, and release a new series. The new series would then be developed to account for the impact of RBC 2 with lower reversionary bonus rates and terminal bonuses, and both of these possible developments could be implemented concurrently.

Over the past few years, par products' bonus rates have declined steadily, primarily due to the poor economic environment, said Choo Oi San, president of the Singapore Actuarial Society. She added that interest rates fell to an all-time low between the global financial crisis and now, and are only starting to recover in recent times.

Ms Choo pointed out that insurers have no incentive to cut bonus rates as they can recognise profits from par businesses only if they declare bonuses under current regulations.

She said: "The sharing is roughly 10 per cent to the insurers and 90 per cent to policyholders. So for every dollar I make, I need to give the policyholders 90 cents before I can recognise 10 cents."

This matter of lower bonuses comes amid fresh criticism from some policyholders that their par policies' bonuses and final payouts are lower than the projected returns at the point of sale.

Is there a more indicative measure of how a par policy is performing, rather than the projected bonus rates shown in benefit illustrations?

One will never know how a policy has performed until it matures, terminates or claims, said Dr Yeo. In the absence of that, he said, projected bonus rates "are the next best thing to use".

"Some insurers do not release their terminal bonus rates. So for such cases, it is difficult to come up with even an estimated return. I prefer to think of my insurance policies as a source of protection and not an investment."

Perhaps what may be more informative to policyholders is to have a further split of the non-guaranteed benefits between those coming from reversionary versus terminal bonuses, said the actuary source. Consumers would then be able to see that products with a high proportion of terminal bonus have greater uncertainty in future payouts, according to him.

READ MORE: How likely is it that par products' bonus rates will be affected?