Tan Kin Lian's Blog: Dubious practices in respect of Terminal Bonus

Wednesday, May 28, 2008

Dubious practices in respect of Terminal Bonus

Dear Mr. Tan,
The article "Salutary bonus lessons from the UK" (Straits Times, 28 May 2008) highlighted that "onerous benefit guarantees were a big factor behind the closure of Equitable Life...".

You have raised some good questions on the risks of terminal bonuses. The declaration of unsustainable annual bonuses was indeed a key factor for the collapse of Equitable Life. However, Equitable life also adopted "dubious practices" in respect of "terminal" or "final" bonuses, and failed to set aside adequate technical provisions for terminal bonuses.

These imprudent practices are highlighted in a BBC article entitled "Where Equitable Life went wrong", which provides a more comprehensive picture of the Equitable Life case. http://news.bbc.co.uk/2/hi/business/3547441.stm

SH

REPLY
The bonus rates declared by NTUC Income in the past were sustainable. In the early 1990s, they were calculated based on a long term yield of 6.5%. In the late 1990s and early 200s, there were reduced to reflect a long term yield of 5.25%. The actual yield earned during the past 10 years was 7.8%.

At any point of time, the bonus rates were adjusted (upwards or downwards) to reflect the projected long term yield of the fund. This projected yield is based on the mix of investments that is prudent for the fund.

It is possible for a life company to declare unsustainable bonus rates. For example, if the bonus rates were calculated based on a projected yield of 10% in today's environment in Singapore, it would be considered to be unsustainable.

NTUC Income did not declare unsustainable bonus rates in past years. In fact, it had been quite conservative in calculating the annual bonus. It kept 20% of the each year's bonus aside, to be declared as a special bonus payable on maturity and claim. This helped to provide a safety margin.

1 comment:

zhummmeng said...: It is not surprising when Mr. Tan showed some sign of relent they immediately went into action to control the damage. They even roped in a UK consultant to lend some support as a 'expert witness'. But wait... it is not over yet. The calm may lull you into resting your laurels.
Mr. Tan doesn't want confrontational does not mean he has accepted . He prefers adopting a more reconciliatory stance so that he will not lose sight of the issues. His contention
still stands , I believe (I am not his spokesman)that the reshaping of the bonus is fraught with a lot of dangers and the unfairness to EXISTING policyholders for no options to choose. Assurance by new management(NM) is one thing. The question is whether it is right or wrong to reshape something when it has been doing fine and in fact going great gun for the company all these past years.
What Mr. Nick Dumbrack, the UK consultant gave was half the story probably because he was given half the story of the current saga.He might have been given the impression that the annual bonus was 'onerous'(unsustainable), therefor he cited the case of EQUITABLE LIFE.But Income's was sustainable.He dwelled at length about the advantage of more exposure to equities and better return for policyholders but he didn't mention about inherent risk and he also didn't tell you what is appended below;

Dubious practices

One device - used by all life insurers to varying degrees - was to stop allocating bonuses to customers policies in the form of "reversionary bonuses".

These were guaranteed and had to be counted on the life insurers' accounts as a liability.

Instead, an increasingly large chunk of the bonuses allocated to policyholders took the shape of "terminal" or "final" bonuses. These could be added or cut with impunity and without affecting the company's solvency - even if they did affect the value the customer expected.

Equitable never even counted part of these final bonuses as a liability.

And it used a range of "dubious" actuarial techniques - also employed by other life insurers - to make it look like it had made a surplus when in fact it had made a loss (Penrose report, p. 689 para 41)

These included devices such as counting future profits - which might never be generated - as an asset in the accounts.

Another was to use financial reinsurance to get a liability off its balance sheet.

I hope this may give a clearer picture of the possibilities of danger and what can be done by those in charge in the unfavourable event like the period Mr. Nick cited of the 2000 to 2003 when the markets were in turmoil.

It is either you heed or you don't. As for the existing policyholders they MUST be given the options to choose and this is the heart of the
issue.; May 28, 2008 8:43 PM