Future Bonus Research Articles

A Small Effort for Future Bonus Demography: Growing the Dream of Orphanage Children

A Small Effort for Future Bonus Demography: Growing the Dream of Orphanage Children

Bonus incentives and losses from early debt extinguishment

An increasing number of firms repurchase debt and recognize associated accounting losses (rather than gains). However, few studies to date have examined the effect of reporting incentives on debt repurchase decisions. We examine the relation between managers' bonus incentives and the recognition of gains or losses from early debt extinguishment (EDE). Our findings indicate that managers tend to recognize disproportionately more losses from EDE when earnings before gains or losses from EDE (i.e., as-if earnings) exceed the maximum performance level set in annual bonus contracts. These results are consistent with the notion that managers' income-decreasing reporting incentives affect debt repurchases. Further analyses indicate that bonus-driven debt repurchases are associated with increases in future bonus awards, but do not significantly affect shareholder value. Overall, our results suggest that managers' bonus incentives are an important determinant of debt repurchases and the recognition of losses.

Reserve-dependent Management Actions in life insurance

In a set-up of with-profit life insurance including bonus, we study the calculation of the market reserve, where Management Actions such as investment strategies and bonus allocation strategies depend on the reserve itself. Since the amount of future bonus depends on the retrospective savings account, the introduction of Management Actions that depend on the prospective market reserve results in an entanglement of retrospective and prospective reserves. We study the complications that arise due to the interdependence between retrospective and prospective reserves, and characterize the market reserve by a partial differential equation (PDE). We reduce the dimension of the PDE in the case of linearity, and furthermore, we suggest an approximation of the market reserve based on the forward rate. The quality of the approximation is studied in a numerical example.

The Effect of Unsuccessful Past Repurchases on Future Repurchasing Decisions

We find that managers are less likely to repurchase stocks when they lose money on past stock repurchases but find no robust evidence that past gains on repurchases influence future repurchasing activity. This asymmetric sensitivity is strongest for young CEOs and those with the shortest tenure. Also, future repurchases are more sensitive to past repurchase losses for CEOs whose previous lifetime experience with the stock market is unfavorable. The sensitivity of future repurchases to past losses costs firms, on average, about 3.7% per year. When this cost is decomposed into systematic and idiosyncratic components, we find that nearly half (1.8%) comes from mistiming idiosyncratic shocks. Past losses on repurchases have a significant and negative impact on the CEO’s future bonus and increase the likelihood that future CEO termination is involuntary. We also find that negative outcomes from past repurchases encourage the subsequent use of dividends. Our findings suggest that outcomes of past repurchases have economically significant consequences through both nonbehavioral (career concerns) and behavioral (snakebite effect) factors. This paper was accepted by Tyler Shumway, finance.

Loyalty Inducing Programs and Competition with Homogeneous Goods

We analyze a market where two firms producing a homogenous good compete by means of two mechanisms: prices and a loyalty reward. We assume that firms act simultaneously when posting their loyalty reward and prices. Consumers who purchase from a firm in the first period lose the reward if they switch providers in the second period. They fully anticipate the effects on future prices of accepting the future bonus and maximize their total surplus over both periods. We first show that there is no equilibrium with prices and rewards equal to zero. We then show the existence of a SPNE where firms are able to obtain half the monopoly profits using large rewards as well as high prices in the second period. We completely characterizeall the symmetric equilibria of the game and show that, ingeneral, firmsobtain positive profits even when they compete in prices, the good is homogenous, and consumers are forward-looking. Finally we show that if firms are allowed to discriminate between old and new customers, the standard zero price Bertrand equilibria reappear.

Trust and adaptive learning in implicit contracts

Trust is a phenomenon that still is quite rarely investigated in agency theory. According to a common intuitive reasoning, trust should develop over time and it should evolve even in finite implicit-contract relationships. However, if the contracting parties are fully rational, theory cannot explain this. We therefore extend the standard model and develop a model of a finite relationship where the principal promises to pay a voluntary period-by-period bonus if the agent has worked according to the implicit agreement. The agent is boundedly rational and unable to foresee the principal’s future bonus decisions. The principal is, with some probability, honest and pays a promised bonus even in situations where ex-post cheating would be optimal. Based on the agent’s adaptive learning process, we show how trust evolves depending on the principal’s bonus-payment strategy. Depending on different levels of the agent’s bounded rationality, we derive the principal’s optimal pure strategy as part of a unique equilibrium. In an extension we show that the results are robust if the agent has bounded recall. The optimal strategy pattern mirrors a subset of trigger strategies which is exogenous in the standard model. Our findings imply that subjective incentives are more effective with increasing tenure of employees, or, that the optimal level of trust depends on how fast work environments change.

On Bonus and Bonus Prognoses in Life Insurance

The surplus on a life insurance policy is defined, at any time during the term of the contract, as the difference between the second order retrospective reserve and the first order prospective reserve. General principles for redistribution of the systematic part of the surplus as bonus are formulated, and various special bonus schemes are discussed. Techniques for forecasting future bonuses are worked out in an extended model with stochastic experience basis. Numerical illustrations are provided.

A theory of bonus in life insurance

The issue of bonus in life insurance is considered in a model framework where the traditional set-up is extended by letting the experience basis (mortality, interest, etc.) be stochastic. A novel definition of the technical surplus on an insurance contract is proposed, and basic principles for its repayment as bonus are discussed. Making the experience basis an endogenous part of the model opens possibilities of model-based prognostication of future bonuses. Numerical illustrations are provided.

Life Insurance Accounting at Current Values: A Danish View

ABSTRACTTraditional life insurance accounting standards rely on various types of book and cost values, the result being that the income and balance sheet statements do not necessarily give a true and transparent picture of the result of the life business. As examples, assets are typically stated at a mix of cost, current and amortised cost values, whereas life insurance provisions are calculated according to the approved technical basis.In this paper, it is suggested that this deficiency can be corrected by preparing life insurance accounts at current value. The proposed method implies that the life insurance provisions shall amount to the present value of the company's net liabilities to the policyholders including a provision for future bonus distribution. Moreover, any unrealized investment reserves are thrown into light, and it is shown how a bonus equalization provision at current value may serve as a key indicator of the financial strength of the company.The method has been designed primarily for the Danish market, but aspects of the method should be of relevance more widely.Finally, the results are illustrated by a number of numerical examples.

With profits without mystery

The paper describes the philosophy of with-profits business which has been developed in the authors' office, as a practical illustration of the running of such business in modern conditions. A description is given of how the philosophy is implemented in the main areas of actuarial management, including valuation methods, bonus distribution, product design and expense control. The discussion is extended to address a number of topics which are the subject of current debate including the financial strength of offices, future bonus prospects and disclosure of expenses.

With Profits Without Mystery

AbstractThe paper describes the philosophy of with-profits business which has been developed in the authors' office, as a practical illustration of the running of such business in modern conditions. A description is given of how the philosophy is implemented in the main areas of actuarial management, including valuation methods, bonus distribution, product design and expense control. The discussion is extended to address a number of topics which are the subject of current debate including the financial strength of offices, future bonus prospects and disclosure of expenses.

With profits without mystery

ABSTRACTThe paper describes the philosophy of with-profits business which has been developed in the authors' office, as a practical illustration of the running of such business in modern conditions. A description is given of how the philosophy is implemented in the main areas of actuarial management, including valuation methods, bonus distribution, product design and expense control. The discussion is extended to address a number of topics which are the subject of current debate including the financial strength of offices, future bonus prospects and disclosure of expenses.

The Valuation of With-Profits Business and the Estate

The subject of valuation is one of the most important, and at the same time most difficult, of all the problems faced by actuaries.The traditional approach to the subject has centred on discussion of the relative merits of the net premium and bonus reserve methods of valuation, and on the inherent conflict between valuation as a means of demonstrating solvency and valuation as a tool for ensuring a smooth emergence of surplus in accordance with the need to declare uniform reversionary bonuses. This approach is covered in the well-known papers by Redington (2) and Skerman (3) (4) and forms a significant part of the course of reading for examination subject 8 (formerly B2).Bonus reserve methods are, typically, ‘active’ methods of valuation in which all relevant parameters, including expenses and future bonuses, are given values close to their expected values. The premium valued is the office premium, and assets are usually valued at market value or by discounting expected investment income. Because actual conditions are always changing, an active valuation method tends to lead to frequent changes of basis and this introduces an element of volatility to the results which can, in consequence, be difficult to interpret. Nevertheless, because of the emphasis on using realistic values for all parameters, it is commonly believed that bonus reserve methods are particularly appropriate for investigations into solvency, especially when external conditions are changing rapidly, and in determining appraisal values.

LAVARACK v. WOODS OF COLCHESTER LTD.

July 19, 1966 Master and Servant — Wrongful dismissal — Damages — Service agreement for annual salary and “such bonus (if any) as the directors … shall determine” — Employee not to invest in competing company without consent of employer — Bonus scheme ended after dismissal of employee — Higher salaries negotiated with employees — Whether future bonus or possible increase in salary to be taken into account — Employee's investment in competitive company — Employment by other company in which employee held shares — Increase in value of shares — Whether credit to be given for increased value of shares and investment in competitive company.

Bonus Maintenance on a Valuation by the A1924–29 Tables

SynopsisAssuming that the A1924–29 mortality will in the future be generally used in life office valuations, investigation is made as to the margin necessary between the rates of interest realised and anticipated in the valuation in order to maintain a simple or compound bonus at the rate of 30s. per cent.It is found that the margin necessary is greater than that deemed sufficient under the OM tables.In the case of a simple bonus, however, it has of course been the practice to value the bonus also at the lower rate, thus making a greater reserve for future bonus than is necessary, while in a compound bonus office the existing bonus has not always been valued at a rate of interest 1½ per cent, lower than that anticipated which would be necessary in order to maintain a future bonus in respect of that existing at the rate of 30s. per cent.It is shown that under the new tables a margin of ¾ per cent, in the case of a simple and ¼ per cent, in the case of a compound bonus is still sufficient to maintain a bonus of 30s. per cent, subject to certain limitations as regards expenses.The necessity of making annual valuations is stressed and approximate methods of computing the fluctuations in the Mortality and Loading profits are outlined.

Bonus Prospects

A very large proportion of the life assurance policies in force in the British Isles give the assured the right to participate in the profits of the issuing office. Where a policy has been effected in recent years, it is almost certainly the case that the assured at the time of making his proposal, was given some indication of the bonuses which he might expect to be allotted to his policy. Sometimes an intending assured merely learns the latest rate of bonus declared, or the rate of interim bonus for the time being in force, by reading the prospectus of the issuing office, while on other occasions figures given verbally by an agent, or in a leaflet or letter describing the proposed policy, contain an allowance for future bonuses. It is almost invariably the case that some information along these lines is given and, no matter how guardedly it is done, the assured regards the figures which he has received as the office's estimate of the bonuses which will in due course be allotted to his policy.

On a Modification of the Net Premium Method of Valuation of Participating Assurances and on the Application of the N–ages Method to the Valuation of Assurances Grouped by Years of Entry and to the Approximate Calculation of Isolated Values of Actuarial Functions

Amongst the disadvantages of the net premium method of valuation are the following: (1) In its application to policies participating under the uniform reversionary bonus plan, the reserve for future bonuses is, in part, secured by the use of a rate of interest remote from the experienced rate.

Bonus Reserve Valuations

These notes assume the reader knows the general principles on which bonus reserve valuations are made.The essential idea is to value as a liability the amounts the office will be liable to pay as sum assured, bonus and expenses, setting of f as an asset the amounts the office will receive—the office premiums. The valuation must be based on really accurate estimates. We must use the mortality we think will prevail and the interest we think can be relied on in respect of existing business. Admittedly bonus is uncertain—a valuation of future bonus does not guarantee it—but the valuation must be as accurate as possible. The bonus allowed for will be realised if the conditions assumed prevail in future.The table of mortality is usually a standard table to which the experience of the office may be regarded as an approximation, but need not necessarily relate to the same class of life. The essential qualification of any table for use must be that it is a real approximation to the likely future experience of the office for which it is used.

Discounted Bonus Policies

The principle underlying all Discounted Bonus Schemes is that the ordinary full profit premium is reduced by anticipating future bonuses. These reduced premium policies are then usually allowed to participate in future bonuses but only in so far as the bonus declared exceeds that anticipated.This class of business was first introduced in 1854, and eventually became popular with a section of the assuring public to whom the benefit of a with-profit policy at a minimum cost made a strong appeal. In the first instance the Discounted Bonus policy made its appearance in connection with a compound reversionary bonus system, but as it grew in popularity it was adopted by other offices and combined with the various methods of bonus distribution.

Notes on the Use of Scales of Premium reduced in anticipation of future Bonuses

The idea of reducing the ordinary with-profit premiums in anticipation of such future bonuses as past experience shows may be safely reckoned upon, is not a modern one. The adoption of such tables has, however, become more common in recent years; and since their use involves the consideration of various practical points of importance—such as the basis upon which the reductions should be computed, the reserves and surrender-values attaching to the policies, the course to be pursued when the profits exceed or fall short of their anticipated amount, and the manner in which the calculations are affected by changes in the rate of interest and mortality—the subject appears to be one well suitable for discussion by this Institute.