Principles and Practices of Financial Management of Guardrisk Life Limited

(Applicable to discretionary participation business)

This document has been issued in accordance with the FSB Directive 147.A.i (LT), and should be read with that directive in mind.

1          Principles of Financial Management

The principles adopted by Guardrisk Life cannot be appreciated without an understanding of Guardrisk Life's business model.

1.1      The Guardrisk Life Business Model

Guardrisk Life operates in the cell captive market, and all discretionary participation business in written in accordance with the unique circumstances of a cell captive business model. In terms of this model, all discretionary participation business consists of policies written to facilitate companies in meeting contractual or constructive obligations to their employees and to their pensioners. These policies consist of disability income policies for employees who are temporarily totally disabled, and annuity policies to assist companies in funding any obligations they may have to continue to provide medical aid cover after an employee has retired. Unlike a traditional insurer, there are no policies sold whose primary goal is for investment purposes.

In a cell captive insurer, each client owns a special class of shares (-L- ordinary shares) in the company, which entitles the client to receive dividends earned on the after-tax profits emerging from the business written in that cell. Each cell is managed independently and contractually ring-fenced against losses made in other cells, and there is no element of cross-subsidy between one cell and another. A variety of types of business can be written in the cells, but in each case, the business will be linked to the cell owner, either through the members being employees of the cell owner, or through the members being customers of the cell owner. The business written with discretionary participation clauses all falls into the former category.

In addition to these types of cells there is also a core cell which houses the share capital and undistributed profits attributable to the controlling shareholder of the company. Profits arise in this cell through the excess of fees charged against the client's cells, over all the management expenses of the company. The only underwriting profit earned in the core cell arises from a few cases where portions of the risk premium are internally reinsured by the core cell, rather than to the external reinsurance market. This core cell also acts as a "funder of last resort" in the event that a cell owner is unable to recapitalise the cell to an adequate level, then Guardrisk Life's core capital can be applied to support the solvency of the cell, while corrective measures are being taken.

A key feature of the discretionary participation business written by Guardrisk Life is that all the surplus earned on policyholder funds (whether from investment returns, expense margins, underwriting profits or any other source) is retained for the benefit of the members of the policies. Shareholder funds (attributable to the "L" shareholders) in the cells are augmented only by investment income attributable to these funds. The rationale for this approach is that the premiums paid into these policies represent a deduction from the employees contribution to retirement funding. If the employer (being the cell owner) were to take profits out of the cell (by way of dividends), this would reduce the employees' retirement funding contributions.

1.2       Reserving Methodology for Discretionary Participation Business

Three types of reserve are created for the discretionary participation business.

a)      Basic liabilities: This contains the liability for the future contractual benefits that are expected to become payable to the members, including any bonuses which have been declared, and incorporates an allowance for future bonus declarations at a sustainable rate.

b)      Bonus Stabilisation Reserve: This is limited to the excess of the maximum possible annuity payment to existing annuitants over the following 12 months (on the assumption that no disabled members recover or die, and that no retired members die or choose to exit from the medical aid scheme), over the expected payment to existing annuitants over the same period.

c)      Profit Share Reserve: This reserve houses all policyholder funds that do not fall into the other two classes, and is made up from all sources of surplus attributable to policyholders (e.g. on disability income policies, any excess of premiums net of expenses over the present value of new disabilities, recoveries (of disabled members) and deaths (of disabled members and annuitants) at a higher rate than assumed in the valuation, investment surpluses, expense surpluses, bonuses lower than the valuation assumption). This reserve is allowed to build up over time, but if it becomes substantial, Guardrisk Life will recommend either a partial or total premium holiday, or a reduction in premium rates.

2         Practices of Financial Management

2.1      Bonus Declarations - Disability Income Policies

Unlike traditional life insurers, the process of declaring bonuses involves interaction with the policyholder. The policyholder will stipulate the desired bonus rate for disability income policies; these are normally in line with the average salary increase paid to the policyholder's active members. Guardrisk Life will evaluate whether such a bonus is affordable out of the cell's resources, drawing upon the Profit Share Reserve, if necessary. If a proposed bonus cannot be afforded using sustainable assumptions, then the policyholder will be advised to pay in additional capital to support the bonus rate. There is no risk of cross-subsidisation between cells, as each cell is required to be independently solvent.

2.2     Bonus Declarations Post-retirement Health Care Liability (PRHCL) Policies

A slightly different approach is adopted for the PRHCL policies. The first step is to evaluate what the maximum sustainable bonus rate is. This will be discussed with the client, and the client will indicate what bonus is rate is desired (normally by reference to the medical aid scheme's average increase rate). If the client's desired rate is lower than the maximum, then that rate will be used. Otherwise, the client will have the choice of accepting our proposed rate, or injecting additional assets into the cell. There is no risk of cross-subsidisation between cells, as each cell is required to be independently solvent.

2.3      Control Measures

All bonus declarations require the approval of the Statutory Actuary, as well as a Board resolution. The initial calculation for the bonus will be performed by Guardrisk Life's actuarial team, and will be signed off by the Chief Actuary. This calculation will include an updated assessment of the solvency of the cell, using current membership, assets and liabilities, and take into account the extent of any Capital Adequacy Requirement that may be needed. This calculation will be sent to the Statutory Actuary, who will review the calculation and supply a letter to the board recommending a bonus declaration. The necessary board resolution will either be circulated by round robin or will be presented at the next board meeting, if appropriate.

Payment of bonuses will not take place until the Statutory Actuary has confirmed his satisfaction with the proposed bonus. If necessary, bonus payments will be backdated to the date of the bonus.

2.4      Conflicts of interest

Due to the fact that the entire surplus is ultimately intended to be distributed to policyholders, rather than be used to generate dividend income for "L" shareholders or ordinary shareholders, the problems of conflict of interest are inherently reduced. The only residual issue is the issue of inter-generational equity. Since the purpose of the policies is to provide a benefit to current or former employees, Guardrisk Life pays particular regard to the wishes and the needs of the employer, while ensuring that desired levels of bonus remain sustainable over the long term.

2.5       Disclosure to Policyholders

The issue of disclosure to policyholders is an important one. Previously, Guardrisk Life did not make a specific disclosure to policyholders, since the process of bonus setting inevitably involves a discussion with the policyholder.? In terms of best practice, disclosure is necessary, even if there is regular feedback and discussions with the policyholder.? Consequently, a brief summary of the PPFM is sent to the client annually, at the time of the declaration of the bonus.

3         Governance procedures

A previous version of this document was presented at the November 2007 Board Meeting of Guardrisk Life. At that meeting, the Board approved the document. Since that time, there have been some changes to the document and the updated version has been ratified by the Board at the May 2008 board meeting.

The FSB Directive 147.A.i requires that an appropriate control mechanism be put into place to ensure that the principles and practices espoused in the document are carried out, and recommends the creation of a Board sub-committee, termed a Discretionary Participation Committee. In Guardrisk Life's case, such a sub-committee would be unnecessarily unwieldy, and it is agreed that the Statutory Actuary will report specifically on ongoing compliance with the PPFM to the Board at the Board meeting where the year-end financials are approved (usually in May each year).