View more on these topics

Profit modelling for pleasure

A major form of entertainment for actuaries in life offices is profit testing. The “beneficiaries” of this work may see it as a black art but the process is actually very straightforward. In essence, all it involves is a comparison of income and outgoings.

If the former exc eeds the latter by a suitable margin you have happy with-profit policyholders and share holders. Otherwise, long faces.

Profit modelling is carried out both before and after products are sold. The work in advance is to predict the likely profit position and to assist in setting the price of the products. The analysis after the fact is to see what actually happened.

The models used by actuaries could be applied to any industry. The principles are universal.

The first stage is to determine cashflow to and from the provider. This is done by type of cashflow and for each time period, often month by month.

The principal inflow of cash is obviously premium income. It is not the only inc ome, however. Receipt of tax relief, capital growth, investment income and other items may also feature depending on the product. The outgoings include expenses, the cost of claims (maturity, death, critical illness, etc), commission, tax and the reserves which must be set up.

Although it may be clear what items make up the cashflow, it may be more difficult to be precise regarding the amounts. Premium amounts are straightforward but other items such as expenses will require estimation.

This estimation will be based on previous experience of selling and servicing similar products. Due to the need to spread the development and other costs, anticipated costs will be dep endent on the volume sold.

If the office is optimistic and assumes a high volume of sales this will spread the costs thinly, resulting in a lower price to the consumer (or a higher anticipated profit).

If those volume sales don&#39t appear, however, the actual profit may be lower than expected or may turn into a loss. The office quantifies the impact of actual experience differing from expectations by scenario and sensitivity testing on a range of different assumptions.

The next stage is to determine the expected cashflow in each time period and to discount them back to the start of the policy to calculate a current or present value.

Many assumptions are required. On the investment side, there are the anticipated levels of income and capital growth. On the experience side, the anticipated levels of deaths, critical illness claims, surrenders and withdrawals.

Like the expenses mentioned, actuaries base their expectations of future claim levels on past experience. If entering a new market, this process will often be assisted by input from reassurers and from national experience surveys of assured lives.

There may be a slight tendency to be on the cautious side but market competitiveness has reduced such conservatism in many areas.

Various profit measures can be drawn from considering these cash flows. The discounted value of future profits is exactly what is says – the cashflow are discoun ted at whatever rate of interest the company chooses.

This interest rate would usually be the rate which the office believes it could earn from less risky activities than launching new products (for example, investing elsewhere) plus a margin.

An alternative measure is the internal rate of return. This is the rate of interest which, when applied to discount the cashflow, results in the sum of those discounted cashflow being zero.

It is effectively therefore the rate of return earned by the product provider for their investment.

Often the cashflow in the early months or years of products are negative. It may take several years for positive cash flows to come through after the issue of a policy to wipe out that initial negative.

The break-even period is defined as the time a policy has to be in force for the sum of the discounted cashflow to be zero.

The principal use of profit modelling before a product goes on sale is to assist in the setting of the price for that product and to determine capital requirements.

The principal use once a portfolio of business exists is to measure the value of that business.

The profit testing of financial products may be a little bit more complicated than in some other businesses but the major principles remain the same.


Chase Fleming Isa is linked to Euro Sicav

Chase Fleming Asset Management is launching its Fleming Funds Isa on January 15. The wrapper provides inv estors with the opportunity to build a portfolio from any of the 17 funds in the FF European-based Sicav. Alternatively, investors can choose one of two special portfolios, created by CFAM. These focus on technology and Europe and […]

Dynamic fund for Merrill

MERRILL LYNCHUK DYNAMIC FUNDType: Unit trust.Aim: Growth by investing in FTSE 100 shares andmedium and small companies.Minimum investment: Monthly £50, lump sum £1,000.Investment split: Minimum of 60 per cent in FTSE 100shares, 40 per cent in medium and small companies.Isa link: Yes.Pep transfer: Yes.Charges: Initial 5.25 per cent, annual 1.5 per cent.Commission: Initial 3 per […]

Chelsea links up with charities

Chelsea Building Society is to launch a second issue of is Call-Direct account. Chelsea is renewing its link with two charities, Shelter and The Guide Dogs for the Blind Association for the launch of Call-Direct (2nd Issue). Chelsea will make a £1 donation to Shelter for every account opened before February 24, 2001, as well […]

AA drives into the IFA sector with annuities

AA Financial Services is re-entering the IFA market with plans to build the UK&#39s number one IFA brand through a new company AAIFA. It aims to build the brand by targeting the AA&#39s 11 million members. The first phase will see AAIFA entering the annuity, Isa, term insurance and investment bond markets by the second […]


Guide: how to change your auto-enrolment support

As we approach the two-year milestone of auto-enrolment, employers have had the opportunity to truly assess the capabilities of their chosen support. They are also now realising that getting to the staging date was the easy part, and that support is required for almost every aspect of the day to day running of their scheme. With the three-year re-enrolment window coinciding for many with the total removal of commission and Active Member Discounts from pension-related products and services, as well as the introduction of the pension charge cap in April 2015, many employers will have no choice but to review their support options. But, what is involved in transitioning your auto-enrolment scheme away from your current support options? This guide from Johnson Fleming aims to outline some of these key areas and provide information and discussion points on what you need to consider.


News and expert analysis straight to your inbox

Sign up


    Leave a comment


    Why register with Money Marketing ?

    Providing trusted insight for professional advisers.  Since 1985 Money Marketing has helped promote and analyse the financial adviser community in the UK and continues to be the trusted industry brand for independent insight and advice.

    News & analysis delivered directly to your inbox
    Register today to receive our range of news alerts including daily and weekly briefings

    Money Marketing Events
    Be the first to hear about our industry leading conferences, awards, roundtables and more.

    Research and insight
    Take part in and see the results of Money Marketing's flagship investigations into industry trends.

    Have your say
    Only registered users can post comments. As the voice of the adviser community, our content generates robust debate. Sign up today and make your voice heard.

    Register now

    Having problems?

    Contact us on +44 (0)20 7292 3712

    Lines are open Monday to Friday 9:00am -5.00pm