SOURCE OF BONUSES.
Never before, owing to the course of financial affairs in the last year or two, and the sudden reduction in interest rates brought about by the conversion of War Loan, has it been so difficult to gauge life assurance profits in the future. The biggest source of profit hitherto has been the excess of the net interest earned on the funds over the rate assumed for the computation of liabilities. British life offices commonly take 3 per cent. as the basis of their actuarial calculations. Any reduction in the rate of interest earned will fall wholly on the marginal profit and will affect that to a relatively greater extent than the proportionate decline in the net interest rate. On a valuation rate of 3 per cent. and an actual net rate earned of 41 per cent. the profit margin is 14 per cent. ; drop of It per cent. in the net rate earned would cut the profit margin down by 50 per cent. This indicates the importance of the interest factor on bonuses.
The net interest rate is what counts—not the gross rate. Income-tax plays a considerable part in life assurance profits. With income-tax at 5s. in the £ a 5 per cent. gross interest rate equals £3 15s. per cent. net. If the gross rate falls to 4 per cent. and income-tax to 3s. in the £, the net interest rate would be £3 8s. per cent. On these bases a decrease of 1 per cent. in the gross rate would be confined to. 7s.. per cent. in the net.
No profit can be truly said to be earned from interest unless the principal is intact. A sum of £100 invested at 5 per cent. will produce in twelve months £5, but if the value of the principal has meanwhile shrunk to £95 the owner at the end of the year is no better off ; he has just 'his original capital and no more. In effect, no interest has been earned. A life office has carefully to preserve the value of its investments because it must always be able to pay .20s. in the £ on its liabilities ; anything less would mean insolvency. The only way that shrinkage of capital value can be made good is out of profits, thereby diminishing the amount available for bonuses.
Previous page
