Smoothed Bonus Policies

03 July 2006 Readers respond

* One step ahead?

Amongst so much useless verbiage issued by the financial services industry your publication is a model of relevance, brevity and ease of use.

Please note that a former employer of mine prior to its becoming demutualised used to keep the profits in its smoothed bonus portfolio. After becoming a company it took the full amount as a shareholder profit.

Heads we win tails you lose.

* Just some comments on the subject of smoothed bonus policies.

It is a fallacy to believe that the insurer actually holds a clearly identifiable set of assets that underpin their smoothed bonus policies or that such a set of assets is properly audited.

The bonuses declared by a life insurance company is a function of its entire business operation, excluding policies with direct market linkage. Thus, HIV Aids, poor administration, poor investment decisions and over-marketing are all factors that will impact on the profits made by the insurer and consequently on the level of bonus declared by the insurer.

They may have a benchmark notional portfolio of assets against which they monitor the liability for their smoothed bonus policies but nothing more than that because once you identify and tie a specific set of assets to a liability class you will have a heck of a job untying that linkage.

Most people (financial advisors) do not understand how a life insurance company works. What was going to happen when I started writing this message was in the province of the actuary - future assumptions. By now some those assumptions have become reality and can be expressed in simple cashflow terms - money in, money out.

For example, Metropolitan Life was unfortunate to report almost right at the bottom of the big market crash 1989. Their chief actuary's report stated that they had to reduce the values of all their smoothed bonus policies (Published financial reports). By the end of 1990 the market had recovered again and one can only assume that they reinstated those values?

Sanlam had an excess of assets over liabilities, in 1983, amounting to 32%. By the end of that decade they were just balancing the books. The decline from 1983 was in annual decrements and contrary to the movement in the JSE All share Index, as shown in the attached graph that starts in March 1985. Their surpluses should have increased right up to about the 1987 crash.

The HIV Aids factor was not an issue in the 80's this leaves one with runaway expenses, unprofitable products and/or bad investment management. The Sanlam expenses reported during those years appeared to be very low compared to their competitors so that leaves only unprofitable products and investment performance.

A product, and here I am speaking only of the investment element of the product, cannot become unprofitable if your overall expenses do not exceed the expense ratio built into the product margins. For example, Lifegro who also had a 30% plus surplus in 1983 was by 1988 running at an overall expense ratio 30%, expressed as a % of recurring premium income (excluding group business), and technically bankrupt. Let us assume that a Lifegro pure investment endowment only had an expense margin of say 15% of gross premium, and you faithfully followed the rules, then you would have to take money from other policyholders, or from your accumulated surplus, in order to balance the books for the company's valuation.

One then draws the conclusion, in the case of Sanlam, that they were making a lot of bad investment decisions because they did not report excessive running costs during the 80's - the rescue of Volkskas / Trust Bank?

Smoothed bonus policies are a lot more complicated than what the life insurers are willing to disclose - Oh! I almost forgot, what about the shareholder's "embedded value"? Asking life insurance companies to be open and transparent is like asking the Pope to give his blessing for birth control.

Things have changed, a bit, but history shows that a person who invests with a life insurance company is mentally challenged!

*A couple of points from your interview with Francois Marais?

If the values compare well with Market related over time maybe the insurers should publish these? The client/advisor can then make an informed choice?

Competitive market forces ensure that the companies declare the highest bonus rates. If Francois was not an actuary I would assume he is taking the mickey out of us. Until recently there was no competition? Once a client had stuck his savings into Sanlam he was locked in, obviously actuaries were not involved in calculating surrender penalties? There is a total lack of transparency in these portfolios - who knows what is happening, maybe the PFA has uncovered some other bulking type of profits as exposed at Alex Forbes?

I think you are right these product are to complex and to secretive? Maybe as claimed the bonus does belong to the member but the insurers have access to cheap funding?

* A true story

I find this article and the associated new of particular interest, especially since my father and I have been trying to get costing information from Old Mutual and Sanlam for more than three months now. They have been unwilling so far to disclose it. [100 plus and reversionary bonus products]

If you look at the performance over 20 years of these portfolios, it is more than 1% lower than the balanced portfolios. According to Sanlam and Old Mutual the portfolio compositions of the balanced portfolios and smoothed products portfolios are very closely related [approx 65 % equity with the balance in property cash and bonds]. Why then more than 1% lower returns [that is over 20 years, so it is fair to assume that all market fluctuations have been smoothed by then] [See attached scanned document from Old Mutual].

The answer to me is very clear. They have been stripping these fund and reserves by very heavy expense fees. Now they are trying to hide it. I know this because after three months of enquiries, I still have nothing. Is this the next big scandal? I certainly think so. What amounts are under management in these funds? Millions? Billions? I don't know.

I can prove every word I say, as I have detailed record of the interactions between the companies and ourselves.

Further on one of the policies that Sanlam administers, they take monthly premiums from clients. They purchase all the units in the beginning of the year by discounting the future premiums by 12%. Clearly, the difference between cost of capital and the discount rate is therefore Sanlam's profit. Once again I have proof on black and white. If not, why not simply buy units as and when the premium is paid? Strange, isn't it? It is very similar to the practive of bulking by Alexander Forbes, just the other way around...

One final question. Why not simply declare the fee structure of these portfolios, in stead of answering an very vague and intelligent sounding replies designed to confuse most people? Unless you have something to hide of course...

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