Apportionment rules: Allocation of BLAGAB income and gains: with-profits funds: FA12/S98
A with-profits fund is a pool of assets backing a defined block of long-term business. The shareholder is entitled to a defined revenue flow from the with-profits fund made up of the shareholder profit each year from the fund less any expenses of administering policies in the fund that are not otherwise charged to the fund. All remaining value in the fund is for the benefit of policies comprising the defined block of long-term business. The fund may contain other business, for example unit-linked or non-profit business. The with-profits policyholders will share the profit on that business. The unit-linked and non-profit policyholders will only get what they are entitled to under their policies.
Solvency II regulations include with-profits funds within the definition of ‘ring fenced funds’.
The assessment of trade profits arising from a with-profits fund is considered separately in section LAM05110.
The commercial allocation of income and gains arising in a with-profits fund for actuarial purposes, rather than tax purposes, derive from the requirements set out in the relevant Principles and Practices of Financial Management (PPFM) which are a regulatory requirement for a with-profits fund.
The PPFM will describe the derivation of the asset share for each policy. This represents the amount within the with-profits fund that notionally backs the future benefit payment due to the policyholder under each policy. Entitlements may also be governed by other documentation, such as Part VII schemes or other legal reconstruction documentation.
Generally, the asset share represents an accumulation since inception of premiums less expenses and payments to policyholders allowing for investment returns earned on the assets backing the asset share (and allowing for policyholder tax where relevant) and perhaps other items. With-profits funds may also have accumulated ‘estates’. The estate is the excess of the total with-profits fund over the sum of all asset shares (or guarantees if these exceed asset shares). An example giving rise to an estate is where investment returns have been good and insurers have been prudent in deciding how much of the return to hold back for future smoothing of benefits.
Hence the allocation of income and gains to asset shares, or via another suitable approach, provides the basis for the apportionment of income and gains each year.
Apportionment based on asset shares
There is no single correct approach for apportionment. Where income or gains arising from an asset (or category of asset) has/have the effect of increasing the asset share of with-profits policyholders it would be reasonable to base a commercial allocation on the asset share split of the various types of policy to whose asset share the income contributes.
For example, if income arose within a with-profits fund whose asset share split between BLAGAB and other long-term business in the proportion 25:75 it may be reasonable to regard 25% of the income as relating to BLAGAB (since it is anticipated that ultimately 25% will be paid out to BLAGAB policyholders).
Not all income from assets held by a with-profits fund contribute to policyholders’ asset shares. Where this is the case any allocation of income should have regard to the purpose for which the asset is held.
For example, a with-profits fund may hold assets to back non-profit (NP) business where the profits of that NP business belong to the with-profits fund. For the I-E allocation you look at the underlying policies the assets back. So the income from assets would be apportioned between BLAGAB and other long-term business based on the business mix within the NP business being supported – for example by reference to mean policyholder liabilities. But when it comes to profit after all the offsets, it would be reasonable for the profits to be allocated according to the with-profits policyholder split. Other methods may be appropriate depending on the particular circumstances.