Annual and Terminal Bonuses

Dear Mr. Tan,
I wish to share my views on this matter. Please post it in your blog.

1) Does terminal bonus smooth returns for policyholders?

Policyholders who have the rotten luck of dying, surrendering (due to unemployment/financial hardships), or whose policy matures (to pay for their children's university education) when the investment markets are doing badly, will see low returns on their terminal bonus policies - perhaps insufficient for their initial plan on how to use the maturity payout.

Policyholders who claims/surrenders/matures during good investment times will be paid the returns shown in the benefit illustration (ie around 3.5% to 4.5%).

But is this fair and equitable? Is this the intention of with-profits life insurance policies?

For reversionary bonus, the impact of investment market volatility on the claimants, surrenders, maturities are significantly reduced, since past bonuses are guaranteed and cuts in reversionary bonus affects all policyholders fairly.

Compare this to terminal bonus which affects only unfortunate claimants in bad investment cycles. Higher reversionary bonus payouts provide higher certainty for all policyholders.

2) Bonuses are not guaranteed anyway, so are they different products?

The provision of certainty and higher bonus-vesting (via high reversionary bonus) adds value to policyholders and is a very different product from the high terminal bonus version.

My friend gave me this analogy. If you ask your investment broker to buy a secure long-term government bond, but instead he gives you a well diversified unit-trust but giving you an excuse that you can expect higher returns, will you be happy with it?

A promise is a promise. Income has promised policyholders a design of high reversionary bonus (low terminal bonuse). Arguably, Income's management does not have the right to change to a low reversionary bonus design unilaterally. In the past, I have personally recommended Income's policies based on this high reversionary bonus design. The move to 'industry practice' is a significant drawback.

3) So what's the value-add of Terminal Bonus? Does it really give higher returns? Are terminal bonus less likely to be cut?

Using an insurance adviser's example, a return of 3.5% is about long-term bond gov rate. Old income policies also returns around the same rate.

Which is more valuable to policyholders, an uncertain return of 3.5% (based mostly on terminal bonus) or a more-certain return of 3.5% (based mostly on reversionary bonus)? Clearly, the reversionary bonus. Bear in mind that 3.5% is about the returns of very secure long-term government bonds anyway.

All else being equal, are policies with high terminal bonus less likely to suffer bonus cuts? Evidently no. Since during the last investment down cycle, industry players cut terminal bonus significantly as well.

4) What about solvency and investment allocation? Terminal bonus approach allows more allocations to high returns/risk assets right?

My recent statistics collated from the MAS website, shows industry players that uses terminal bonus approach have on average solvency ratio of 300%, equity investment ratio of 20%-30%. What level of solvency ratio is adequate? Is 300% too high?

Bearing in mind, MAS minimum is 120% at company level. Are these companies being too safe at the expense of policyholders? With such a comfortable buffer of 300% solvency ratio, shouldn't allocations to risky investments be higher?

Yew Ming