POLICE MUTUAL ASSURANCE SOCIETY. Principles and Practices of Financial Management July PPFM v16.4

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1 PPFM v16.4

2 1. INTRODUCTION Purpose and History Fair and effective management Overview Principles of Financial Management Practices of Financial Management Arrangements for Change Corporate structure PRINCIPLES OF FINANCIAL MANAGEMENT Our Overarching Principle The amount payable under a policy Setting regular bonus rates for a with-profits policy Setting final bonus rates for a with-profits policy Smoothing of with-profits policies Investment strategy Charges and expenses Business activities and risks Management of the inherited estate New business PRACTICES OF FINANCIAL MANAGEMENT Product structures Conventional with-profits Unitised with-profits (UWP) The amount payable under a policy With-profits: General Conventional with-profits Unitised with-profits Non-profit Unit-linked Setting regular bonus rates for a with-profits policy Setting final bonus rates for a with-profits policy General Conventional with-profits Unitised with-profits Smoothing of with-profits policies General Conventional with-profits Unitised with-profits Investment strategy General Matching Limits on Asset Classes Specific Portfolio Restrictions: Liquidity, Credit Risk and Derivatives Changes in Asset Allocation Assets that would not normally be traded Charges and expenses Allowance for expenses incurred: General Allowance for expenses incurred: Conventional with-profits Allowance for expenses incurred: Unitised with-profits Other charges to asset shares Business activities and risks Management of the inherited estate New business APPENDIX: DEFINITIONS PPFM v16.4

3 1. Introduction 1.1. Purpose and History Police Mutual was formed by Police officers for the benefit of Police officers and ultimately the Police service. It was formed with the encouragement and support of the Police service and the Home Office. The Memorandum and Rules of the Society set out the purposes of the Society and define the basic rights of all members and the responsibilities of the governing bodies The purpose of the Police Mutual Group is to improve the lives of the Police family and we offer this to the Military and others who lay their lives on the line and those who support them Police Mutual Assurance Society ( the Society ) is the parent company of the Group. The main purpose of the Society is the carrying out of long term insurance business for the benefit of its members and persons connected with them. This generally means the sale and administration of protection, savings and investment related insurance products. Where these products are not or cannot be offered by the Society using the Life Fund they are provided by subsidiary companies or in partnership with other organisations or related parties The purposes of the Society also include social or benevolent activities which are not inconsistent with the other purposes of the Society The Society is owned by its members. All policies issued by the Society qualify the policyholder for membership and the terms of such Membership are contained in the Memorandum and Rules of the Society. Police Mutual s rules also allow the Committee of Management at its discretion to widen the range of products that confer membership of the Society to certain products sold through our subsidiary companies. These wider products are called eligible products. This is to ensure that the main products customers of the Police Mutual Group buy confer membership and enable access to our developing member benefits. In return, income generated by our subsidiary companies from selling those eligible products helps fund member benefits for all members. The list of eligible products will vary from time to time at the Committee of Management s discretion but includes, for example, home and motor insurance Although over time the management of the Society has changed and become financial industry professionals, the organisation still operates to the same overarching purpose and with on-going direct and indirect support from the Police service which in turn benefits its members. The Managing Board regularly considers the impact and importance of this support on the Society s members and business activities Senior members of the Police service acting as the Committee of Management, together with serving officers and Police staff through our Annual General Meeting, oversee that the running of the Society is consistent with the interests of both the Society s members and the Police service The Society currently has the following policy types which confer membership: Conventional with-profits: Taxable Endowment, Tax-Exempt Endowment, Low Cost Endowment, Special Endowment, Minimum Low Cost Endowment and Children s Bond. Unitised with-profits pensions: Top Up Pension Plan (TUPP), Group Personal Pension (GPP). PPFM v16.4 1

4 Unitised with-profits lump sum: Platinum Bond and Guaranteed Investment Bond (GIB). Unitised with-profits Individual Savings Account (lump sum and regular contributions): Guaranteed ISA (GISA). Non-profit: Mortgage protection (various versions), level term assurance (various versions), level term assurance with return (Panda), whole of life assurance (Police 4000), family income benefit, convertible term assurance, temporary annuities. Unit-linked: Stakeholder Pension, Child Trust Fund. The first four categories of policy fall within the definition of with-profits policies and the last two categories are classified as non-profit policies The Society currently has, and has had in the past, a number of combination policies. These are policies that are combinations of the policy types specified above. Each component part of these policies is dealt with separately and typically in exactly the same ways as other policies of that policy type The Society offers membership to all policyholders in the Life Fund and to policyholders of eligible products bought through its subsidiaries. The Managing Board and the Committee of Management periodically consider which policies or products qualify for membership. They would take appropriate advice, including from the With-Profits Committee and With-Profits Actuary, before making any changes to the membership criteria or issuing new categories of policy in order to protect the rights and interests of existing members In 2015 the Society introduced an additional category of affiliate membership so that groups of people connected to organisations other than the Police service could receive products issued by the Society. The Committee of Management will determine from time to time the eligibility criteria for affiliate membership and the membership benefits available to affiliate members. The membership rights, benefits, restrictions and obligations of members and affiliate members may not be the same and are set out or determined in accordance with the Rules. However as holders of policies affiliate members will receive the same benefits under their policies as members receive under the same policies. Therefore for the purposes of these principles and practices of financial management the references to members will, unless specified otherwise, include affiliate members Fair and effective management The Society has a framework in place to ensure that it manages the Life Fund fairly and effectively, and in accordance with regulations The Memorandum and Rules are the formal and most important governing documents for the Society. They form a contract between the Society and each member of the Society. The Rules set out the powers and duties of the Managing Board and the Committee of Management. In managing the Society the Rules give the Managing Board and the Committee of Management some ability to use discretion. The exercise of discretion is particularly relevant in relation to the management of the with-profits business written in the Life Fund but discretion is also exercised in respect of decisions potentially affecting other categories of policies, such as investment policy and management of the inherited estate These Principles and Practices of Financial Management (PPFM) were originally designed to explain to with-profits policyholders how the Managing Board manages the financial aspects of the with-profits business of the Society and in particular how it exercises the discretions available to it in managing with-profits business. As the Society conducts other insurance business in the Life Fund and PPFM v16.4 2

5 continues to grow and evolve the mix of its business, the Managing Board and Committee of Management have considered that it would be beneficial to extend the scope of the PPFM. They have been extended to explain the nature and extent of the discretion available to the Managing Board and the Committee of Management with regard to the operation of the long term insurance business of the Society more generally and to show how potentially competing or conflicting interests of different groups and generations of members or potential members holding with-profits and other types of policy are managed so that they are treated fairly. We also produce consumer friendly versions which include the key points of the full PPFM and which are sent out with Key Features Documents and Yearly Statements A sub-committee of the Managing Board, the With-Profits Committee, meets on a regular basis to review whether the business has been managed in compliance with the PPFM and to provide independent judgement as to how the Managing Board has addressed, or seeks to address, any conflicting rights and interests of policyholders. This sub-committee has a majority of non-executive representation and an independent Chairperson In addition, the Society has a With-Profits Actuary who is specifically appointed under Prudential Regulation Authority (PRA) regulations to advise on the fair treatment of different groups of with-profits policyholders and the application of discretion by the Managing Board in operating the Life Fund On an annual basis, the Managing Board and the With-Profits Actuary make a report available to policyholders confirming whether the Life Fund has been managed in accordance with the PPFM. 1.3 Overview The Society s with-profits business is written in the Society s long term business fund which is referred to as the Life Fund or fund in this document. As the Society has a single life fund, non-profit business is also written in the Life Fund and the resources of the Life Fund are also used to provide working capital for the Society and may be applied for other purposes of the Society as envisaged in its Memorandum and Rules The Principles and Practices of Financial Management summarises the principles and practices the Society uses in managing its business for the benefit of its policyholders and members in accordance with its rules and purposes. It reflects a combination of current practice, past experience and past considerations as to the management of the Society s with-profits and non-profit business, as well as taking into consideration of how the Society would expect to react to future external events such as changes to the economy and other developments affecting the scope and nature of its business A wide range of potential future operating conditions has been considered within the financial management framework described in the PPFM. It is difficult, if not impossible, to foresee all future possibilities. Consequently, in certain extreme conditions, it may be necessary to depart from the principles and practices described here Terms in italics are defined in the Definitions in the Appendix at the end of this document None of the contents of this document form part of, or vary, the terms or conditions of any policy issued by the Society. In the event that there is an PPFM v16.4 3

6 inconsistency with the Rules or Memorandum of the Society, the Memorandum and Rules will take priority. If there is an inconsistency between the contents of this document and any policy, the terms and conditions of the policy will take priority. 1.4 Principles of Financial Management The Principles are enduring statements of the overarching standards the Society adopts in managing the Life Fund They describe the business model used by the Society in meeting its duties to policyholders, members and other stakeholders and in responding to longer-term changes in the business and economic environment. 1.5 Practices of Financial Management The Practices describe the Society s approach to managing the Life Fund and to responding to changes in the business and economic environment in the shorter term. Reviews will take place at least annually but may not require changes to be made These Practices are intended to contain sufficient detail to enable a knowledgeable observer to understand the material risks and rewards from effecting or maintaining a policy with the Society. 1.6 Arrangements for Change For any change to the Principles of Financial Management, the Society will send its policyholders written notice, setting out the proposed changes, three months in advance of the effective date of the proposed changes unless the Financial Conduct Authority has granted a waiver of this requirement The Society s Practices are expected to change as the Society s circumstances and the business environment change. The Society will send its policyholders written notification, setting out any changes to the Practices of Financial Management of the Society. This notification may be in arrears but will be within a reasonable time period from the effective date of the change The Society would only change a Principle or Practice if it is considered justified by the need to: Respond to changes in the business or economic environment; Protect the interests of policyholders or categories of policyholders; Change a Practice to better achieve a Principle; Correct an error or omission in the PPFM; or Improve the clarity or presentation of the PPFM Any changes to either the Principles or Practices will be approved by the Managing Board who will seek appropriate actuarial advice and the views of the With-Profits Committee. 1.7 Corporate structure Police Mutual Assurance Society Limited is an incorporated directive friendly society As a mutual organisation the Society has no shareholders. PPFM v16.4 4

7 1.7.3 The Society uses a number of subsidiary companies and related parties to offer additional products and services. The details of the Society s corporate structure can be found on its website. PPFM v16.4 5

8 2. Principles of Financial Management 2.1. Our Overarching Principle Where discretion is to be exercised and there is the potential for material impact on current or future policyholders or groups of policyholders or other stakeholders, the Managing Board will act in accordance with the Memorandum and Rules of the Society, consider appropriate actuarial advice, the views of the With-Profits Committee and the With-Profits Actuary and the impact on the rights, expectations and interests of all current and future policyholders (including in their capacity as members) as well as the custom and practice of the Society The amount payable under a policy With-profit policies The methods that the Society uses to determine the amount payable under a with-profits policy aim to reflect the share of the Life Fund attributable to that policy. This share of the Life Fund attributable to a policy makes allowance for all relevant charges, expenses, mortality and investment experience of the Life Fund during the lifetime of the policy as well as any discretionary adjustment to reflect the other business activities of the Society and the management of the inherited estate made under 2.8 and 2.9. The share of the Life Fund attributable to a policy is the basis for determining a with-profits policyholder s entitlement and expectations under the policy and (save to the extent that his or her policy benefits from any guarantee) he or she has no entitlement (or expectation) to receive benefits beyond the share of the Life Fund attributable to that policy The amount paid on exit is subject to smoothing. The amount paid on death and maturity will not be lower than the guaranteed benefits where a guarantee is given The methods used to calculate the amount payable under a with-profits policy involve a degree of approximation, for example in determining historical assumptions for which there are not detailed records. Such approximations would not significantly affect the decisions that the Society makes in managing its with-profits business Because of these approximations, historical assumptions or parameters may be changed. Such changes would usually result in a more accurate determination of the amount payable, or enable a more efficient determination of the amount without significant loss of accuracy If a change to the calculation method is made then the effect of the change is calculated. Any material change to the calculation would be agreed by the Managing Board after taking appropriate actuarial advice and consulting the With-Profits Committee Non-profit policies For non-profit policies currently offered, the amount payable on a claim is fixed at the start of the policy. The premiums to be paid are also fixed for the whole term of the policy. The Society may introduce products where a fixed premium may be subject to review and change at appropriate intervals in line with the policy conditions. See also and PPFM v16.4 6

9 Unit-linked policies For unit-linked policies, the contributions paid are used to buy units in the relevant unit-linked fund. At any time, the value of the policy is the number of units held multiplied by the unit price. This value depends on the value of the investments made, the charges and any tax that has been taken from the policy. The level of charges is set out at the start of the policy but may be subject to review in line with the policy conditions Setting regular bonus rates for a with-profits policy Regular bonuses may be added to a with-profits policy depending on investment performance and the operating experience of the Life Fund Once added, regular bonuses cannot be removed. The aim in setting regular bonuses is to distribute that part of the investment return and profit of the Life Fund which is reasonably certain, whilst maintaining a reasonable margin for final bonuses. The Society considers both past and prospective investment returns and the solvency of the Life Fund when setting regular bonus rates Policies based on the same underlying endowment premium rates and which were effected at the same time will have the same regular bonus rate declared. Where different underlying premium rates or product structures are used, the Society may choose to declare a different regular bonus The Society reserves the right to introduce a new bonus series on existing premium rates, subject to obtaining actuarial advice. The investigations specified in would indicate whether a new bonus series was appropriate Regular bonuses are reviewed once a year as part of the year end investigations. However, relevant investigations are carried out throughout the year The Society may change the interim bonus (see ) during the year, and on more than one occasion, if investment conditions change significantly so that the supportable regular bonuses change significantly The Managing Board decides what regular bonus to declare in line with the Overarching Principle (see 2.1) and having taken the advice of the With-Profits Actuary and the With-Profits Committee Setting final bonus rates for a with-profits policy The share of the Life Fund attributable to a with-profits policy is used as a guide to setting the final bonus rate or final bonus. This share of the fund is subject to smoothing Conventional with-profits policies based on the same underlying endowment premium rates and which were effected at the same time for the same term will have the same set of final bonus rates. The final bonus rates depend on the duration in force at the time of a claim. As for regular bonus rates, the Society reserves the right to introduce a new bonus series on existing premium rates, subject to obtaining appropriate actuarial advice. Where different underlying premium rates or product structures are used, the Society may choose to declare different final bonus rates. PPFM v16.4 7

10 For unitised with-profits policies, the amount of final bonus added is calculated at an individual policy level and will change at the same frequency as the unit price. The Society reserves the right to change the final bonus system on existing premium rates, subject to obtaining appropriate actuarial advice No guarantees are made about the rate of final bonus or that there will be a final bonus. Although the final bonus will not be negative, on unitised with-profits business the Society is able to impose a market value reduction in certain circumstances. The Society reserves the right to change its final bonus rates and final bonuses at any time without advance notice For conventional with-profits business, final bonus rates are reviewed at least annually. However, particularly in times of significant market movements, the level of current payouts compared to asset shares will be considered; and in order to protect the solvency of the fund or to prevent payouts diverging too far from asset share, additional bonus rate declarations may be made For unitised with-profits business, payouts including any final bonuses or market value reductions are set for each individual with-profits policy according to a prescribed formula The Managing Board decides what final bonus rates to declare in line with the Overarching Principle (see 2.1) and having taken the advice of the With-Profits Actuary and the With-Profits Committee Smoothing of with-profits policies The Society takes the same approach to smoothing on maturity and death claims. A different approach is taken for surrender claims The Society s intention is that smoothing should be neutral over the long term for maturity and death claims, i.e. over the long term with-profits policyholders should receive in aggregate the share of the Life Fund attributable to those policies, including the deduction of the charges described in 2.7. Smoothing is intended to create neither a profit nor loss to the Life Fund in the long term At each bonus rate declaration and periodically in between, the cost of smoothing to the Society is calculated. There is no formal monetary limit on this cost. However, if the cost is felt to be excessively high or low then this may indicate that another bonus rate declaration is required The degree of smoothing for surrender claims is less than that for maturity and death claims. On the surrender of all policy types, the claim value more actively reflects changes in the underlying asset values. For unitised with-profits policies this is done through a market value reduction and for conventional with-profits policies this is done through the surrender basis. Changes in surrender bases and in market value reductions reflect changes in underlying asset values but also reflect changes in other items, for example expenses Investment strategy All the policies of the Society, except unit-linked policies, are invested in the Life Fund The Society s investment strategy will have regard to the nature of the liabilities of the Life Fund and will seek to optimise the investment return while recognising the need to be able to meet guaranteed benefits and to safeguard the financial PPFM v16.4 8

11 security of the fund. In determining the mix of assets between asset classes the investment strategy will take into account the financial strength of the fund, its ability to meet its regulatory capital requirements, and the long term expected returns anticipated for each asset category together with their volatility. The Managing Board will set the investment strategy also having regard to the Overarching Principle (see 2.1), the management of the inherited estate (see 2.9) and the Memorandum and Rules of the Society Different investment strategies may be used for the inherited estate, the shares of the Life Fund attributable to with-profits policies and other parts of the Life Fund. There are also separate unit-linked sub-funds which have different investment strategies. Different investment strategies may also be used for new classes or series of policies. This would only be done where the Managing Board believes it would improve returns or reduce the risk for policyholders or facilitate fairer treatment of different generations or types of policyholder or where it would enable it to better meet its risk appetite. The Managing Board would operate this discretion having regard to the Overarching Principle (see 2.1), the management of the inherited estate (see 2.9) and the Memorandum and Rules of the Society The Society operates its investment strategy in line with specified investment policies and controls. The investment policies and controls are approved by the Managing Board. They set out the assets in which the Society can invest and limits on the Society s exposure to different classes of asset. The investment policies also include limits on the exposure to various counterparties to reduce the risk of loss resulting from the failure of a third party Derivatives and other instruments may be used within limits set by the Managing Board for efficient portfolio management and to control and mitigate investment risk. Investments in derivatives are not made for speculative purposes Charges and expenses In calculating the share of the Life Fund attributable to a policy for conventional with-profits policies, an allowance is made for the Society s expenses. The aim is that all of the Society s expenses incurred in a specific year are allowed for in the calculation except where they are offset by charges made to policies other than conventional with-profits policies or offset by income from subsidiary companies or otherwise charged to the inherited estate. Unitised with-profits policies have expense charges which may only be changed in line with the terms of the policy and where applicable under the PPFM Any change to the basis on which expenses are allowed for in this calculation would usually be made with the purpose of a more accurate reflection of the amount attributable to a policy Any compensation costs incurred by the Society would typically be borne by the inherited estate The Society reserves the right to make additional charges to with-profits policies to reflect the cost of smoothing, the cost of guarantees, the use of capital and the management of the inherited estate. This will affect the share of the Life Fund attributable to a with-profits policy. The Society currently makes a charge to with-profits policies to reflect the cost of guarantees The Society s close affinity with the Police service helps to keep charges and expenses low, for example through payroll deductions and low costs of marketing. The Managing Board will consider the importance of maintaining PPFM v16.4 9

12 these benefits and the relationship with the Police service in assessing whether to provide discretionary benefits to members, the services it provides or the business activities that it undertakes Business activities and risks The Society is a mutual organisation owned by its members and it has no shareholders. The Society designs its products and services around the particular needs of its members. The Society works with the Police service to assist them where this would benefit its members. The Society s strategy and business plan are approved each year by its Committee of Management as being in the interests of and meeting the needs of its members and ultimately the Police service. As the Society has no shareholders, it is able to take a long term view of its members interests and those of the Police service All policies are written in the Life Fund. Security is provided to the Society s members and policyholders through the inherited estate. All profits and losses that are not applied directly to the share of the Life Fund attributable to a policy accrue to the inherited estate. The Managing Board may decide in exercising its discretion under the Rules, to provide additional or special benefits to some or all groups of members from the inherited estate, or reduce costs and/or charges in line with The Society limits the taking on of business risk through its approval and oversight processes. Before taking on any significant new business activity or risk, it must be approved by the Managing Board who would consider the costs and benefits and risks to any category of policyholder of entering into such a venture in line with the Overarching Principle (see 2.1) The underlying objective of any venture would be to provide short or long term value to current or future members or deliver a service that would, in the opinion of the Managing Board, be in the members interests. This does not preclude the possibility that losses could occur. Any losses from business ventures would be borne in the first instance by the inherited estate However, should the inherited estate fall below the level required to maintain solvency of the fund as a going concern (see 2.9) or to otherwise meet the Society s risk appetite then relevant losses or costs would be allowed for in the calculation of the share of the Life Fund attributable to a with-profits policy and where appropriate and permitted the claim values of other policies or the level of charges made to those policies. The Managing Board would consider the views of the With-Profits Actuary and the With-Profits Committee in these events Management of the inherited estate The Society s inherited estate is that part of the Life Fund not directly required to meet the liabilities of the Society including expected benefit payments (including future bonuses) for current policyholders which for this purpose also includes any part of the Life Fund earmarked or identified by the Managing Board for their benefit (whether collectively or for groups of policyholders) It is the working capital of the business. Additions to the inherited estate are not typically earmarked for particular uses and are generally available for wider working capital purposes as set out below. All current and future members (other than affiliate members) have an interest in the inherited estate as described in below. PPFM v

13 There is no established practice of any particular percentage of the inherited estate being distributed to any particular group or groups of members or policyholders or of any particular group or groups of members or policyholders having any priority interest in the inherited estate. No current member has any entitlement to participate in distributions out of the inherited estate, either in his capacity as member or as policyholder. Any such distributions are at the discretion of the Managing Board as described in and in exercising that discretion they will have regard to the Overarching Principle (see 2.1). Current and future members (other than affiliate members) have contingent interests in the inherited estate but these interests may change and vary over time and with circumstances The primary uses of the inherited estate are: To meet statutory solvency and internal capital requirements. This allows the Society to demonstrate its ability to maintain solvency in adverse situations. To give investment freedom for with-profits policyholders. This allows the Society to follow an investment strategy that should increase returns above that that would be possible without the inherited estate. To provide working capital. To provide capital support for guarantees. To finance other business ventures. See 2.8 and 3.8 for more details on this. To enable smoothing of investment returns and payouts. To meet any excess of costs over charges for business other than the conventional with-profits business. To meet any exceptional costs in managing the business arising as a result of legislation, taxation or other circumstances which in the opinion of the Managing Board should not be directly charged to policyholder benefits While not a primary use, the inherited estate has been and is used to support the Police family and benevolent activities associated with it. This principle was confirmed at the Society s Annual General Meeting in 2011 as being in the interests of its current and future members. When evaluating such uses the Managing Board will seek to ensure that security of policyholders benefits is not endangered and their benefit expectations are not materially affected as well as considering the extent to which current and future members have benefitted from support from the Police service given to the Society or might be expected to in the future A specific benevolent activity is the use of the inherited estate to support the Police Mutual Foundation where this is subject to annual review based on the following criteria: Affordability That any yearly allocation to the Foundation will not have an adverse impact on the interests of with-profits policyholders Wider considerations of fair treatment for all policyholders Evidence that the inherited estate has cumulatively grown as a consequence of management actions by more than the aggregate amount used for Foundation purposes A review as to the effectiveness of the Foundation in helping protect and promote the interest of Police Mutual s members and customers Ongoing compliance with regulatory capital requirements The Society manages its inherited estate by any of the following or a combination of any of them: pursuing its business plan and attendant revenue and profit targets, amending investment strategy, amending charges and by controlling the addition of regular and final bonuses on with-profits policies, in order to ensure it is adequate to meet both the regulatory requirement and the internal assessment PPFM v

14 for capital as a buffer against adverse circumstances. The means by which the inherited estate is managed in any particular circumstance is determined by the Managing Board in line with the Overarching Principle (see 2.1) The Society s intention is that the inherited estate should be large enough to support the activities described in this section and its risk appetite. However, the Society will not actively increase the size of the inherited estate beyond the needs of ensuring it is adequate for this purpose The desired level of the inherited estate is formally considered as part of an annual capital review process by the Managing Board In accordance with the Rules the Managing Board is permitted to, and may, exercise discretion regarding any distribution from the inherited estate to members. In exercising this discretion the Managing Board may decide (although not forming part of policyholder entitlements under their policies) to pay additional or special benefits to members holding some or all categories of policies and/or exercise some favourable discretion in the pricing, underwriting criteria or the claim values paid for some or all policy types as the Managing Board considers appropriate having regard to the purposes of the Society. To the extent that it exercises this discretion it will do so in line with the Overarching Principle (see 2.1) and it will reflect affordability considerations, the financial position of the Society, the nature of the relationship the Society has with the Police service, the risks borne by its members by virtue of the jobs they undertake and other criteria which may be unique to them or groups of them The Managing Board applies a number of risk frameworks and regularly considers whether any of risks recorded might have an impact on the management of the business, the inherited estate or the Life Fund. This formally occurs as part of the Society s business planning process but tracking the risk frameworks takes place more frequently. In extreme cases, these factors may lead to the Managing Board deciding to reduce or change business activities, restrict new business or take other appropriate actions New business Because of the Society s low expenses and because no commission payments are made, there is very little new business strain. Plans for new business are reviewed by the Managing Board yearly and the views of the With-Profits Committee are sought as part of this process If the volume of new business is sufficiently high that the capital strain placed on the Life Fund threatened either the solvency of the fund or the benefit expectations of policyholders then the Managing Board may choose to limit the new business volumes of one or more products If the expected profitability of a product either through low volumes of business or the burden of expenses is such that it becomes potentially non-viable then the Managing Board may then choose to withdraw the product from sale Also, other changes may occur in, for example, the regulatory environment or taxation which would make a product non-viable. The Managing Board may then choose to withdraw the product from sale In the event of a closure to significant amounts of new business or with-profits new business, the Society would: PPFM v

15 Review its investment policy with respect to all or part of the Life Fund and may, for example, move assets from equities to fixed interest to more closely match liabilities. Review the prospects for any new or different types of business. Review the extent to which with-profits payments were being smoothed. Review the management of the inherited estate to assess the appropriateness, in the opinion of the Managing Board, of making a distribution. If a distribution of some or all of the inherited estate is decided to be appropriate then the intention would be to ensure an equitable distribution by way of bonus or other benefit to the remaining members of the Society. In deciding what may constitute an equitable distribution the Managing Board would bear in mind a number of considerations which would indicatively include: - The types of policy which may receive such distributions - The extent to which policies or policy types or member groups have contributed to or benefitted from the inherited estate including the extent to which they have borne risk - The amount or value of the policy or policies held by members or groups of members - The duration of policies or membership - Factors that may be relevant to the timing of or the decision to consider and make an equitable distribution of the inherited estate or how different members might be treated after such a distribution is made PPFM v

16 3. Practices of Financial Management 3.1. Product structures Conventional with-profits An initial guaranteed amount is given, the endowment sum assured. This is the minimum amount that will be paid on maturity or earlier death Regular bonuses may be added to the endowment sum assured each year depending on investment performance and the operating experience of the Life Fund. Regular bonuses are added on the policy anniversary. However, the bonus does not become guaranteed until the bonus declaration for that calendar year. Until a bonus becomes guaranteed it is called an interim bonus. Regular bonuses and interim bonuses are only paid on maturity or death The Society currently uses a super-compound bonus system. This means that the regular bonus consists of two parts. The first is a percentage of the endowment sum assured and the second is a percentage of the regular bonuses already accrued Because of the different bases for calculating endowment sums assured, different bonus series are used for Minimum Low Cost Endowments, Children s Bonds and then all other policy types At maturity or on death, a final bonus may be paid in addition to the endowment sum assured, regular bonuses and interim bonuses There is a separate final bonus for each policy term. There are separate final bonus scales for Minimum Low Cost Endowments, Children s Bonds and then all other policy types The final bonus is expressed as a percentage of the endowment sum assured plus regular bonuses plus interim bonuses On surrender no guarantees apply either to the amount paid or the method used to determine the surrender value Unitised with-profits (UWP) This category includes the Top Up Pension Plan (TUPP), Platinum Bond, Guaranteed Investment Bond (GIB), Guaranteed ISA (GISA) and Group Personal Pension (GPP). The details of these policies differ but the underlying structure is the same For the GPP, each payment buys a number of Shadow units. For the other UWP products, each payment buys both Guaranteed units and Shadow units, giving a Guaranteed Fund and a Shadow Fund for each policy. For TUPP, Shadow units are bought at the unsmoothed Shadow Fund Unit Price. For the other UWP products, Shadow units are bought at the smoothed Shadow Fund Unit Price; however in some unusual conditions we may choose to use a Special price for the GIB, the GISA and the GPP (see for further details). The smoothed and unsmoothed Shadow Fund Unit Prices are discussed below in and PPFM v

17 The price of Shadow units changes in line with changes in the underlying asset values. A Shadow Fund Unit Price is calculated each week. For the Platinum Bond and GIB, a deduction is made for the tax expected to be paid by the fund in respect of the investment return attributed to these policies. This is the unsmoothed Shadow Fund Unit Price. When multiplied by the number of units held it gives the unsmoothed Shadow Fund A smoothed Shadow Fund Unit Price is also calculated. This price is the average unsmoothed price over the last 26 weeks, multiplied by an interest adjustment and an asset share factor (see for details). Multiplying the number of units held by this price gives the smoothed Shadow Fund Units are cancelled from the Shadow Fund to cover the following charges: initial charge, renewal charge (taken monthly) and alteration charge (if applicable, TUPP only). For TUPP, Shadow units are cancelled at the unsmoothed Shadow Fund Unit Price. For the other UWP products, Shadow units are cancelled at the smoothed Shadow Fund Unit Price; however, in some unusual circumstances, a Special price may be used for GIB and GISA (see for further details) Regular bonuses may be added to the Platinum Bond and TUPP depending on investment performance and the operating experience of the Life Fund. For Platinum Bond, the Guaranteed Fund is increased each week in line with the declared regular bonus rate by increasing the Guaranteed Fund Unit Price. For TUPP, the Guaranteed Fund is increased each month in line with the declared regular bonus rate by creating additional units of equal value. The GIB, the GISA and the GPP have no regular bonuses For the TUPP, units are cancelled from the Guaranteed Fund to cover an initial charge, a renewal charge (taken monthly) and an alteration charge (if applicable). Charges are not deducted from the Guaranteed Fund of the Platinum Bond but a surrender penalty is applied on surrender within the first five years. No charges are taken from the Guaranteed Fund of GIB or GISA For TUPP units bought prior to 1 May 2003, there is a guarantee that the regular bonus rate will be at least 3.5% each year. For other units there is no minimum guaranteed rate of bonus In certain circumstances the Shadow Fund may be lower than the Guaranteed Fund. The difference between these two values is called a market value reduction or MVR. If the MVR switch is turned on, then in these circumstances certain claim values will be subject to a minimum of the Shadow Fund, i.e. the MVR will be applied. If the MVR switch is turned off, then in these circumstances certain claim values will be subject to a minimum of the Guaranteed Fund, i.e. the MVR will not be applied. It is anticipated that the MVR switch will usually be turned on. See and for further details of when a market value reduction is applied to claim values There are no guarantees on the GPP. Therefore, there is no market value reduction or final bonus on this product. The payout is determined by the Shadow Fund For certain claims on the other UWP products, the claim value is subject to a minimum of the Guaranteed Fund (i.e. no MVR will be applied). These claims are: For Platinum Bond, on surrender on tenth (or subsequent quinquennial) anniversary; PPFM v

18 For Platinum Bond, partial withdrawals up to 7½% of the initial investment each year; For GIB, on surrender on fifth (or subsequent quinquennial) anniversary; For GISA, on surrender/transfer out at guarantee points. A guarantee point occurs five years after the end of the tax year in which payments are made and at subsequent quinquennial points thereafter (i.e. payments made during each tax year, as measured at 5 th April are guaranteed on 6 th April in five years time and every five years thereafter); For TUPP, on retirement from main scheme or at the specified age; and For all four products, on death (on Platinum Bond, GIB and GISA the death value paid is 101% of the value of the policy). Any final bonus will be calculated by reference to the smoothed Shadow Fund. However for GIB and GISA, in some unusual circumstances, the value of the Shadow Fund may be calculated using a Special unit price (see for further details), so that a final bonus is calculated with reference to the unsmoothed Shadow Fund. See for details of the final bonus calculation and for details of the smoothing practices On other claims for the other UWP products, if the smoothed Shadow Fund is greater than the Guaranteed Fund then the smoothed Shadow Fund is used to determine a final bonus for the policy. However, in some unusual circumstances, a Special unit price may be used for GIB and GISA (see for further details), so that a final bonus is calculated with reference to the unsmoothed Shadow Fund. On Platinum Bond surrenders where a final bonus is payable, if the smoothed Shadow Fund is greater than the Guaranteed Fund then the smoothed Shadow Fund will be used to determine a final bonus for the policy. On TUPP transfers where a final bonus is payable, the greater of the smoothed Shadow Fund and unsmoothed Shadow Fund is used with reference to the Guaranteed Fund to determine a final bonus for the policy. For Platinum Bond surrenders where an MVR is applied, if the smoothed Shadow Fund is less than the Guaranteed Fund then the unsmoothed Shadow Fund will be used to determine a market value reduction. For TUPP transfers where an MVR is applied, the minimum of the smoothed Shadow Fund and unsmoothed Shadow Fund is used with reference to the Guaranteed Fund to determine a market value reduction. For GIB and GISA surrenders where an MVR is applied, if the smoothed Shadow Fund is less than the Guaranteed Fund then the smoothed Shadow Fund will be used to determine a market value reduction. However, in some unusual circumstances, a Special unit price may be used for GIB and GISA (see for further details), so that an MVR is calculated with reference to the unsmoothed Shadow Fund. For Platinum Bond surrenders where an MVR is not applied and there is no final bonus, the Guaranteed Fund is paid subject to any surrender penalty. For Platinum Bond surrenders in the first five years, a surrender penalty or an MVR may be applied but not both. See for details of the final bonus calculation and for details of the smoothing practices For GIB, GISA and GPP, in some unusual circumstances, the unsmoothed unit price (i.e. a Special price) may be used for the Shadow Fund at the discretion of the Society. This would be triggered by the unsmoothed Shadow Fund Unit Price varying significantly from the smoothed Shadow Fund Unit Price (in either direction). The level of variance is kept under review. Our current practice is that if the unsmoothed price fell to such an extent that it was more PPFM v

19 than 5% below or increased to such an extent that it was more than 5% above the smoothed price we could decide to use the unsmoothed price (i.e. the Special price), until such time as it was decided that we no longer wished to make this adjustment. The trigger point at which a move to the unsmoothed price is made (and the point at which a move is made back to the smoothed price) will depend on several factors including the level of investments and claims, and the volatility of investment markets, and is at the discretion of the Society For Platinum Bond and GIB, payment of an amount equal to at least the initial investment is guaranteed on the tenth (Platinum Bond) or fifth (GIB) anniversary and on subsequent quinquennial anniversaries thereafter (reduced if any income is taken). If the value of the Shadow Fund is less than the Guaranteed Fund at any of these guarantee points, the Shadow Fund will be increased up to the level of the Guaranteed Fund. This will be done by creating more Shadow Fund units on the policy. If the value of the Shadow Fund is greater than the Guaranteed Fund at any of these guarantee points, the Guaranteed Fund will be increased up to the level of the Shadow Fund. This will be done by creating more Guaranteed Fund units on the policy, effectively resetting the guaranteed amount to this new higher level For GISA, payment of an amount equal to at least the amount invested is guaranteed five years after the end of the tax year in which payments are made and at subsequent quinquennial points thereafter (reduced if any withdrawals/transfers out are made). If the value of the Shadow Fund relating to payments made during a particular tax year is less than the Guaranteed Fund relating to the same tax year at any of these guarantee points, the Shadow Fund will be increased up to the level of the Guaranteed Fund. This will be done by creating more Shadow Fund units on the policy. If the value of the Shadow Fund relating to payments made during a particular tax year is greater than the Guaranteed Fund relating to the same tax year at any of these guarantee points, the Guaranteed Fund will be increased up to the level of the Shadow Fund. This will be done by creating more Guaranteed Fund units on the policy, effectively resetting the guaranteed amount to this new higher level. PPFM v

20 3.2. The amount payable under a policy With-profits: General The current methods used by the Society to determine the amount payable under a with-profits policy are approved by the Managing Board. The detail of these methods is documented internally. The PPFM provides an overview of those methods The internal documentation includes the details of the historical assumptions used and of the computer model used in the calculations The documentation and practices below refer to the Society s current approach. Calculations may have been done differently or more approximately in the past Changes in the methods, parameters and assumptions for calculating the amount payable under a with-profits policy are approved by the Managing Board, after taking appropriate actuarial advice and consulting the With- Profits Committee The same approach to determining the amount payable is used for all the conventional with-profits policies. A different approach is used for the unitised with-profits products. Both approaches are covered here Conventional with-profits The Society uses asset share as the starting point for determining the amount payable under a policy. In normal circumstances, the asset share is calculated once a year as part of the year end valuation of the Life Fund. The asset share may be estimated at other times of the year A policy s asset share is calculated as: premiums paid accumulated with investment returns less allowance for expenses less allowance for the cost of life cover adjusted for tax (if applicable) The investment return is the actual investment return for the assets backing the asset shares reduced by an amount to reflect the cost of guarantees. This reduced return is used to accumulate the premiums paid In some circumstances, as determined by the Managing Board having considered the advice of the With-Profits Committee, the asset share may be adjusted to allow for other items (e.g. profits/losses from other sources and management of the inherited estate). This adjusted asset share is the share of the Life Fund attributable to a policy. It is subject to smoothing Our current practice is that surrender values are based on 95% of the share of the Life Fund attributable to a policy. The surrender factors used are usually calculated once a year. In times of significant market movements, calculations may be more frequent. For this purpose shares of the Life Fund attributable to policies are averaged over all policies issued in a particular year for a particular term. Some limited smoothing of the surrender value factors is done, in that surrender values are normally calculated just once a year. Surrender values are calculated using factors that reflect the share of PPFM v

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