Life Assurance Bonus Prospects
DOES the reported intention of the Government to issue 3 per cent. bonds presage a general fall in interest rates ? The question has a special interest for holders of policies participating in "the profits or surplus of life assurance offices. Life. assurance bonuses are on a more liberal scale than ever before and one of the chief factors contributing to this satisfactory state of affairs is the high investment yields that have been obtainable for some years past. A general fall in interest rates would, therefore, seem to involve a reduction in bonuses, but the proposition is not so simple as it appears.
Changes in interest rates do not immediately affect bonuses or, to a material extent, the average return on the funds of a life office. The average return is only gradually affected by the yield on new investments. The progress of modification depends upon the proportion of new investments to old and, generally speaking, this is very small, for an assurance office meets its liabilities out of current income and not by the sale of securities. The new money for which employment has to be found consists of the excess of income over expenditure. In addition, the proceeds of investments redeemed or realized have to be reinvested. Redemptions and realizations may, and frequently do, result in a profit on book values of the securities, and this would be available to make good any shrinkage in interest earnings.
A decline in interest rates would be attended by a rise in the value of existing securities and the gain in ,this respect would temporarily outweigh the lower rate of interest on new investments. But if this appreciation be treated as a realized profit the average interest return on the old investments would be brought down. The average yields shown by insurance offices on their investments is to some extent the product of directorial policy, and bonus prospects of individual offices vary according to the policy pursued in the past. Offices which have written up the book value of their securities to market value have automatically reduced the subse- quent average interest return. Offices which have followed the opposite policy of taking no account of appreciation on the book value of their securities should Show • a higher average interest return in the future than those whose security values have been written up.
BONUSES AND NORMAL SURPLUS.
Some offices which have written up the market value of their securities have retained part or the whole of the appreciation in hand, either placing it to reserve or leaving it in the undivided surplus carried forward. Where none of the appreciation has been distributed the position is much the same as where it has been ignored, as, though the nominal rate of interest is less, the actual amount of interest earned is unchanged by what is really a bookkeeping operation. These points are not always clear from life accounts despite their important bearing on bonus prospects. It is essential to know the actual surplus for the valuation period from normal sources of profit and what proportion of the normal surplus was absorbed by the bonuses declared. An Office which distributed only a portion of its normal surplus is in a better position to_ withstand a fall in interest rates than one which drew upon the sum brought in or on precarious sources of profit like appreciation. • However appreciation may be dealt with there is only one way of dealing with depreciation and that is by immediate full provision. If book values be written up they at once exhibit depreciation on any adverse turn of markets and this depreciation must be prOvided for out of the surplus, reducing the sum available for dis- tribution by way of bonus. Offices which have not taken appreciation into account can see it all run off again before the need arises for making a draft on the surplus. The profit accruing to a life office from interest earnings is the difference between the net rate earned and the rate assumed for valuation purposes. The standard valuation rate of British offices is 8 per cent., but a few offices base their calculations on a 24 per cent. rate. An. office valuing at 8 per, cent. and earning 44 per cent. net shows a profit ratio of 14 per cent. A drop of 4 per cent. in the net interest rate would reduce the profit from interest by a third,. In the case of an office valuing at 24 per cent. and earning 44 per cent. net the profit from interest would be reduced by a quarter. _ We use the figures mentioned simply to illustrate the differential strain on surplus by falling interest rates. Such a large drop as 4 per cent. in the average return is not likely to occur except over a prolonged period. It is the effective rate of interest that counts—not the gross rate. A fall in gross interest rates, by enabling the 'Government to convert the national loans on favourable terms, might Conceivably result in the reduction of the income tax. In that event, as the benefit would operate on the total investment income, the average net return might tem- porarily rise, or at any rate its decline would be retarded.
Conversion, on the other hand, will present its own problem to the life offices. A large part of their funds are invested in Government stocks and a curtailment in the yield on these would be a serious blow. The alternative would be to accept redemption in cash, as this will pre- iumably accompany any conversion offer, but the rein- vestment of the enormous sum involved at a satisfactory rate would be difficult.
Important sources of life assurance profits besides excess interest are a more favourable mortality experience than estimated and savings on the amount allowed for expenses. Owing to various reasons people are living longer than formerly and this produces, as rates of premium for participating assurances have remained unaltered, a larger profit for life offices. The probability is that the longevity of policyholders will continue to increase, adding further to life profits. Speaking generally, the effect of any probable decline in interest rates within the next few years on life assurance profits or surplus is likely to be partly compensated by gains in other directions, though the results of individual offices may vary. Where distributions have been limited to normal profits bonuses should be maintained for some years ahead. El M. TOovEv.
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