:: CEO's Statement on Bonus Re-structure

:: Chairman's Speech at the AGM

Version as at 26 May 2008

Introduction

In April 2008, NTUC Income announced a re-structuring of the bonus with respect to life policies incepted after 1993.

We decreased our annual bonus from 2.3% to 1.3% of the sum assured and increased our special bonus from 25% to 30-120% (for policies ranging from 20 years to 2 years).

The policyholder benefits are not impacted by the re-structure.

For the convenience of our customers, we are pleased to set out a list of frequently asked questions in relation to our bonus re-structuring exercise.

Important Points

1. Are you taking more risks with my policy?
   
   No, we are not taking more risks. In fact, with the new bonus structure, we are taking less risk.
   
   The Life Fund's exposure to higher-yielding investment instruments such as equities and properties are in the range of 35-40%. The rest are in lower-yielding instruments such as bonds and fixed income instruments. This has been the case for the last ten years, and we do not plan to change the combination. Hence, the overall investment risks do not increase. We need a yield of 5-6% in overall returns for all policyholders and this combination will deliver that yield.
   
   As the old bonus structure would tie down more of our assets in bonds and fixed income instruments, the exposure to equities and properties would drop to below the 35-40% range. This is partly due to the fact that bond yields have declined from 6.0% in 1993 (when the effected polices also known as the “L series” products were introduced) to 3% in 2007. As a high annual bonus rate is dependent on high bond yields, this investment combination will not be optimal, and would impede our ability to deliver good overall returns to policyholders.
   
   If we continue to pursue our old investment policy without a change in bonus structure, we will introduce more risk. To pursue a 35-40 % exposure in equities and properties would subject us to volatilities which we may not able to absorb under the old bonus structure. The old bonus structure contributes to a rapid build up of guarantees, which necessarily require bond investments.
   
   If we do not continue with the investment combination with 35-40% in equities and properties, we may not be able to deliver overall returns to policyholders.
   
   Changing the bonus structure, and giving policyholders protection in returns through special bonuses, is really in the best interests of policyholders.
   
   
2. Why can’t you give us an option to stay within the old bonus structure?
   
   The old annual bonus rate is not sustainable because bond yields have dropped over the years, from 6% in 1993 to 3% in 2007. A high annual bonus is dependent on a high bond yield. We do not foresee bond yields returning to a rate of 6% in the near future. Remaining within the old structure will therefore mean a reduction in overall bonus rates.
   
   An additional reason relates to the nature of the Life Fund. All participating life insurance policies belong in one Life Fund. The attraction of a participating life policy is that it is able to obtain stable returns over time against market instability.
   
   In order to achieve the stability in returns, the fund has to be managed as a single diversified pool. All policies belonging to the same bonus series were priced on the same basis and should be treated identically to enjoy similar benefits. To treat them differently raises many questions of allocation of investment returns which will make the fund impractical to administer.
   
   In order to ensure that the Life Fund and consequently, our policyholders stand to get the best returns possible, we made the decision to not provide an option.

Glossary

Both annual and special bonuses are methods used to distribute profits to our participating policies. Annual bonuses (also known as reversionary bonuses) are allocated yearly to all policies.  Special bonuses (also known as terminal bonuses) are allocated on exiting policies by way of a claim, maturity or surrender.

Calculation

Participating Policies

Our annual bonuses on participating policies, are expressed as X% @ Y%. This means that the annual bonus is:

X% of basic sum assured
Y% of accumulated bonus

For example, if your policy has a Sum Assured of $100,000 and Accumulated Bonuses of $20,000; and we declare a bonus rate of 2.6% @ 2.1%, your annual bonus for the year will be:

$100,000 * 2.6% + $20,000 * 2.1% = $2,600 + $420 = $3,020

FREQUENTLY ASKED QUESTIONS

1. Will policyholders be worse off as a result of the change?
   
   Policyholders will not be worse off.  When we decided to change the bonus structure, the first priority that we set was to protect the policy benefits and yields.  We made it our goal that projected benefits will not be reduced because of the change.  This change improves investment flexibility and resilience.  This will increase the likelihood of meeting or exceeding projected yields.
   
   
2. Special bonuses are not guaranteed.  Will they be reduced in a year of poor investment returns?
   
   Our Special Bonus scale is designed to compensate for the difference between the old annual and new annual scale.  We did so for 2008 and intention is to do so for each year going forward.  This is subject to Life Fund achieving good long run returns and we are financially strong (if this were not the case, then bonuses will be reduced regardless of whether they are annual or special) and where investment outlook permits.
   
   The new flexible bonus structure also allows us to pass on bonuses above these set of special bonuses if investment results are especially good by giving additional special bonuses to reflect the investment gains.
   
   Furthermore, since we only need to pay special bonus on exiting policies (maturities, claims, surrenders), as opposed to annual bonus being allocated to all, special bonus is affordable.  Even in a difficult year, there is a better chance of us sustaining the bonus payouts if your policy is maturing, or if you surrender or make a claim.
   
   
3. Is the bonus allocated fair?
   
   Bonuses are allocated in a way which reflects the experience of the fund.  It is the responsibility of the Appointed Actuary to ensure the fairness of the allocation.  Both the annual and special bonus rates were derived on the basis of an actuarial study conducted over several months.  Under MAS regulations, the Appointed Actuary has to justify the recommendation to the Board of Directors.
   
   
4. What changes did NTUC Income make to the bonus structure?
   
   We reduced annual bonuses. We increased with a matching (or slightly more) increase in the special bonus to compensate.  Instead of distributing bonus largely based on 1 year's return, we look at the average of 5 to 10 years returns.
   
   
5. Do the changes benefit the policyholder now and in the future?
   
   Yes, the new bonus system will benefit policyholders.  This is because it improves investment flexibility and resilience.  This will increase the likelihood of meeting or exceeding projected yields.  It will also means that annual bonuses will be more stable and avoid repeating the sharp bonus cuts of 1997, 2001 and 2002 which reduced the total benefits received by the policyholder.
   
   There is no change to the amount you will receive if you surrender or make a claim now. In fact, you may even get slightly more.
   
   In coming to this decision on the bonus change, we have given considerable thought to what was good for our customers now, in the short term, and in the long run.
   
   
6. I heard it is better to have a policy with higher annual bonus than a policy with lower annual bonus but higher terminal (special) bonus. Is this true?
   
   No, this is not the case.  A policy with high annual bonus and a low special bonus is not necessarily better than a policy with a low annual bonus and a high special bonus.
   
   The total return on your policy is contributed by both annual and special bonuses, not solely by annual bonuses. A policy with lower annual bonus and higher special bonus need not give a poor return because by having a lower annual bonus, it means that the company is able to be more flexible in our investments in order to gain higher investment returns for the benefit of policyholders. See Question 5 for a more detailed explanation.
   
   In the past, we maintain a high annual bonus, and a low constant special bonus, and we distribute bonuses based largely on past 1 year's returns.
   
   Annual bonus once declared is vested to your policy account, and it is guaranteed. Once declared, it must also be declared for all policies.
   
   If we continue to declare high annual bonuses each year, it increases the amount of guarantees in our life fund. With higher guarantees, increasingly amount of our assets have to be invested in conservative instruments like bonds. This reduces our investment flexibility and the potential to invest in assets such as equities and properties that can earn us better return in the longer term.
   
   Also, this would mean that in a difficult investment year, it is very likely to cut annual bonus, simply because it does not have the resources to allocate high annual bonus to each and every policy account.
   
   
7. Can you explain how the new structure is going to improve my chances of attaining the projected yields?
   
   Under the new structure, we shift a portion of the annual bonus to the special bonus. Thus annual bonus starts low, with a compensating higher special bonus. The final effect on total bonus is the same as under the previous structure. All things being equal, we will still pay on the surrender value, claim, or maturities the total bonus as before.  Just that the proportions of annual and special bonuses have changed.
   
   It makes no difference how much of this total bonus received by the policyholder is made up of annual or special bonuses. Eventually, it is the total payout to you that really matters.
   
   However, because special bonus is not guaranteed, we do not need to reserve for special bonus the same way we do for annual bonus. That is, we need not lock increasingly amounts of our assets in conservative assets.  We have the flexibility to invest and in the long run, generate better returns on our investments. Because of this, there is also a greater chance of an upside in the future, of us delivering more than what we have projected.
   
   Furthermore, since we only need to pay special bonus on exiting policies (maturities, claims, surrenders), as opposed to annual bonus being allocated to all, special bonus is affordable. Even in a difficult year, there is a better chance of us sustaining the bonus payouts if your policy is maturing, or if you surrender or make a claim.
   
   Moreover, part of the changes is that we will distribute bonuses based on averages over 5 or 10 year periods, instead of basing it merely on past 1 year. But this is always subject to the financial strength of the fund and investment outlook.  By using averages, it means that extreme returns are smoothed out and bonuses need not rise and fall according to the volatile market movement.
   
   
8. Can you explain what you mean by smoothing? Do you have any figures to substantiate that using moving averages will reduce volatility?
   
   When you use averages, there is a natural tendency for extreme figures to be smoothed out.  For example, in an exceptionally bad year, a negative 5% return would translate to only a 0.5% drop in a 10 year average computation.  This means that your bonuses, whether annual or special will not fluctuate.

   Below are the 1-year and 10-year average returns since 2001. You will notice that there is only one year when the figure drops below 5.25% (4.6%. in 2003), the long term target rate.

   	1-yr return	10-yr avg return
   2001	2.6%	6.9%
   2002	2.3%	6.5%
   2003	10.0%	4.6%
   2004	8.9%	5.7%
   2005	6.8%	5.8%
   2006	10.8%	6.3%
   2007	10.7%	7.8%

   
   
   
9. Special bonus is not guaranteed, and will only be payable to me when my policy matures, or when I surrender or make a claim. So how do I know it is not being used for anything else?
   
   The only change we made is to shift part of the proportion that would have been paid out as annual bonuses into special bonuses. Although the special bonus does not vest into your policy account, it continues to remain in the life fund that belongs to you and all life participating policyholders.
   
   The money did not go anywhere else. This explains why there is no change to the total amount you will receive when you make a claim or surrender your policy. The amount or the yield (the only important measure) you receive remains unchanged.
   
   We do this, so that we do not have to reserve for bonuses (special) in the same way. By doing this, we strengthen our financial position to better weather storms in the market. Besides the point on strengthening our financial position, the primary basis of special bonus is to return the excess gains from our investment (which is not returned by annual bonuses).
   
   
10. Is the new bonus structure a sound practice?
    
    This practice is wide adopted by insurers in the world that sell participating policies, and regarded as best practice by actuaries all over the world.  Extensive research has also been conducted over many years by actuaries and academics to demonstrate the soundness of this approach.  In fact, in Singapore, most other life insurance companies have adopted this practice for many years.
    
    The practice of having a lower and stable annual bonus was evolved from the hard lessons learnt from the more developed insurance markets.  For example, in the United Kingdom, only annual bonuses were distributed in the 1850s to 1950s. Eventually, the concept of a special bonus was invented.  By passing on some of the investment gains as special instead of annual bonus, companies could invest more flexibly and increase the overall benefits to policyholders.  This is why companies in UK and Singapore declare a stable annual bonus and special bonus.
    
    In Scandinavian countries like Sweden, insurers in the past tried to out-perform each other by declaring high annual bonuses.  But they found that the annual bonus rates were too high to be sustainable, and threatened the solvency of the fund.  Today, Swedish insurers declare only special bonuses.
    
    
11. With this change, does it mean that NTUC Income is no different from any other (commercial) insurer?
    
    As stated in Q10, this practice of using low annual bonus and high special bonus is accepted as a sound and prudent approach worldwide. It is used by all cooperatives, mutuals or commercial insurers in UK. As a cooperative, we also have the responsibility to ensure that the business is run on a financially sound basis and invested in a way that delivers good returns.
    
    The difference is that we return the surplus to our policyholders instead of our shareholders.  Our shareholders continue to take only 2% of the surplus. It is independent of the bonus structure.
    
    For commercial insurers, most will declare up to the maximum dividend allowed (which is 10% in Singapore) to their shareholders.
    
    
12. Although I can now understand the rationale for the change, it still does not explain why NTUC Income did not increase the total bonus for 2007 when investment return was 10.7%. How do you explain this?
    
    Our 2007 investment returns were good. However, as explained above, we do not distribute bonuses based on one year's returns alone. We look at the moving averages over 5 to 10 year periods.
    
    Furthermore, although how much we pay out largely depends on smoothed investment returns, we also need to consider the future outlook.  By the last quarter of 2007, there was turmoil in the market with the sub-prime meltdown, credit crunch, slowdown in US economy. Given the situation, it would not have been appropriate or prudent to increase the bonus payouts.
    
    Even in today's relative calm and stability, the outlook still is uncertain.
    
    
13. How is the special bonus set? Was it arbitrary?
    
    The determination of the special bonus is certainly not arbitrary.  When we decided to change the bonus structure, the first priority that we set was to protect the policy benefits and yields.  We made it our goal that projected benefits will not be reduced because of the change.
    
    What we did was to take the old bonus scale and calculate the policy values. Then we take the new bonus scale and calculate policy values on this.  We then set the special bonus such that it will make up the difference of the annual bonus.
    
    We will perform such a test for each year going forward with the intention to target a minimum special bonus.  This is subject to Life Fund achieving good long run returns and we are financially strong (if this were not the case, then bonuses will be reduced regardless of whether they are annual or special) and where investment outlook permits.
    
    The new flexible bonus structure also allows us to pass on bonuses above these set of special bonuses if investment results are especially good by giving additional special bonuses to reflect the investment gains.
    
    Both the annual and special bonus rates were derived on the basis of an actuarial study conducted over several months. Under MAS regulations, the Appointed Actuary has to justify the recommendation to the Board of Directors.
    
    
14. Is Income reducing annual bonus or special so that it can have more money to spend e.g. on advertising or other activities?
    
    The main purpose of the bonus re-structure is to bring about the benefits we have laid out in our earlier answers. As explained earlier, the monies continue to be ring fenced in the life fund which belongs to the policyholders.
    
    
15. I am still more comfortable with a higher annual bonus. This is because special bonus is not guaranteed, and annual bonus is guaranteed once declared and vested. What can you say about this?
    
    A policy with a high annual bonus and a low special bonus is not necessarily better than a policy with a low annual bonus and a high special bonus.
    
    The total return on your policy is contributed by both annual and special bonuses, not solely by annual bonuses.  A single’s year annual bonus is only a small part of the total benefits.
    
    In any case, bonuses are never guaranteed. Under the previous structure, although it is true that whatever is declared is guaranteed, there we cannot guarantee to continue declaring attractive annual bonuses in the future.
    
    The new bonus system is more flexible and will give us a better chance of delivering projected yields.
    
    
16. Will Income use high projections to sell policies and suddenly cut special bonus?
    
    We will not. Our Special Bonus scale is designed to compensate for the difference between the old annual and new annual scale when we have earned the adequate return and the fund can afford it (see question 11). It is gradual and does not suddenly jump at certain durations.    It is not designed to maximize our projections.  Projections are regulated by the Life Insurance Association and all companies use the standard investment rates to illustrate their projected returns.  In the projections, both annual bonus and special bonus are shown in the non-guaranteed cash and protection values and in the illustrations, they are jointly reflected as a total non-guaranteed amount.
    
    We would like to assure all our customers that NTUC Income would not resort to tricks or provide misleading information to sell more policies.
    
    
17. I can’t tell the new annual and special bonus set for my policy. Is NTUC Income trying to hide? There doesn’t seem to be enough transparency and disclosure.
    
    

    Here, we list a few ways which you can clearly see the annual and special bonuses.

    1. Our past years’ bonus rates declared are shown in the bonus letter sent to all policyholders whose policies are affected by a change in bonuses.
       
       
    2. In addition, if the plan is still on sale, past years’ bonus rates are also stated in the product summary.
       
       
    3. Policyholders can also request for a copy of the post sales illustration to see how the future estimated values under their policy would change over time.
       
       
    In principle, policyholders should see that there is none or little reduction in the overall projected returns under their policy. This is because we have ensured that the change in bonus structure is neutral, and it would protect policyholders such that they would not lose out in terms of earning a lower return.
    
    
18. So can I say safely that Income did not cut my bonuses?
    
    That is correct. We did not cut bonuses, we are reshaping bonuses.  Overall, the yields to policyholders are protected.  Special bonuses have increased to top up any shortfall between the new and old bonus structure.
    
    
19. Why is the bonus reshaped only for policies issued after 1993? Why not for all policies? The choice of policies for reshaping sounds very arbitrary.
    
    Policies issued after 1993 would now have been in force for at most 15 years. If a bonus reshape takes place now, we will be able to have sufficient time to invest flexibly in order to achieve a higher return for these policies.
    
    Policies issued before 1993 would have invested for a very long duration (e.g. 20 years or more) and are close to maturity. If we subject these policies to the bonus re-shaping, the effect will be minimal for these classes of policies.
    
    
20. Is MAS aware of this change in bonus structure?
    
    Our Board of Directors approved the bonus re-structure.  MAS has been kept informed of the change.
    
    
21. Could I have been given an option?
    
    The Board of Directors and the management have the responsibility to run the business on a financially sound basis. They also have the duty to look after the benefits of all our policyholders.
    
    Allowing policyholders the option to choose will introduce constraints and complexities in our operations and hamper our ability to bring about the intended benefits of this change.
    
    Although we understand the sentiment and preference of some policyholders, we have to do what is better for policyholders as a whole.
    
    We will try our best to let policyholders understand this change.
    
    Considerable thoughts and debate have taken place before we decided to carry out the reshaping.  This is done in the best interest of our policyholders.