Unfortunately, few bonus systems are as uncomplicated as that. Many companies announce "interim" bonuses every year but compound them only every three years.
Thus, a company paying £14% compounded triennially would add £11120 to the £13,000 sum assured for each of the three years in the first triennial period, at which point it would be level pegging with the simple bonus system. But for the next triennium the bonus would be 4% of £13,360, and so on thereafter. In addition, many offices have a two-tier bonus system: one rate of bonus is paid on the sum assured, and then a further, sometimes higher, rate of bonus is paid on the bonuses.
Thus a company might pay £14% compounded annually plus £16% on the bonuses attaching. On our £13,000 policy this would mean that after Year 1 the sum assured would be £13,120 + 6% of £11120 = £16, making £13,126; after the second year it would be £13,263.60 (£13,126 + 4% = £13,251 + 6% of £1251), and so on.
Nor is this all. Since the 1990s many companies have introduced yet another category, the terminal bonus, also sometimes called a capital bonus. This is usually paid as an addition to reversionary bonuses and is declared and payable only at maturity or death. Its original purpose was to allocate capital gains over the life of the policy, and since market prices can change substantially, it was also held that terminal bonus rates would alter to take account of these movements. In practice, however, companies using terminal bonuses have split into two camps, those that do adjust them according to market experience (some of these, for example, raised their terminal bonus rates substantially in 2016 when the stock market was high and lowered them sharply in 2013 when it was low) and those that have chosen to maintain terminal bonus rates at a specified and unchanging level.
Terminal bonuses are declared in two ways.
Some companies declare them as a percentage of the sum assured for each year or number of years a policy has been in force, for example, 1% of the sum assured for each policy year.
Others declare them as a percentage of the total bonuses already allocated to the policy, for example, 20% of all bonuses attaching.
With all these different bonuses and variations, it is easy to get confused.
But as far as the individual is concerned the main thing to realise is that the different systems are all aimed at the same thing, distributing the surplus achieved by the life insurance company according to the success (or otherwise) of its investment management.
When quotations are obtained, it will often be found that two or more offices with different bonus systems will quote very similar estimates of the maturity value of a policy with a given annual rate of premium. And, so far as the buyer of life insurance is concerned, the relevant questions are how policies compare with each other and which is best for him. In the case of with-profit (or participating) policies there is no alternative to the assistance of a professional adviser who is well versed in the market and can do the spadework for you. A couple of general points can, however, be made.
The first is that, over a short term, life offices using a simple bonus will often produce better results (i.e. maturity values) than those using compound systems (see Table 2 for some specimen figures). The reason is that the simple rate of bonus is likely to be a good deal higher than the compound rate and it will take the latter some time to catch up. Over the longer term, the compound rate will almost certainly produce better results.
Protection policies, as we shall see, are fairly straightforward. But in investment-oriented policies a number of factors enter into any comparison of value. The most important concern the various methods of distributing a surplus among the policyholders. In conventional companies, the method of distribution is the bonus system. The with-profit policyholder, having agreed to pay a given premium for the guaranteed sum assured, has bonuses allocated to his policy from time to time, and by the maturity date these can add up to a very substantial sum, far exceeding the sum assured itself.
There are... see: Bonus Systems