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The Actuary The magazine of the Institute & Faculty of Actuaries

With-profits can be defended

Hugh McKee’s defence of with-profits contracts in the January/February 2003 issue disappoints. Properly designed, with-profits policies offer significant advantages:

  • As policyholders provide the risk capital, they offer better value where shareholders are capital constrained, or have profit targets higher than those available in investment markets.
  • Policyholders wanting to spend rather than reinvest their proceeds will almost certainly prefer smoothed returns.
    • On the other hand, discretionary bonuses pose an unacceptable risk to policyholders. Hugh McKee is dangerously wrong in thinking that the actuary offers protection. Bonuses are decided by boards of directors, who are quite capable of not following the advice of the actuary. He says that ‘there is little evidence of actions being taken favouring shareholders over policyholders’. This is not my experience, which I am happy to share in as much detail as he cares to hear. In my opinion, the very existence of significant orphan estates is a prima facie argument that profits were unnecessarily retained.

      My suggestion is that the need for discretion arises from a failure to think through the issues. My article in the September 2002 issue suggested an objective algorithm for determining bonuses that was smooth, demonstrably fair, and prevented anti-selection. There may be other algorithms. Questions of solvency can be addressed by non-vesting bonuses and adequate access to capital. If discretion was ever justified, I am convinced it is no longer so.