Why a Projection Needs an Audit
A dividend and bonus projection can contain several different kinds of amounts: a basic contractual benefit, bonuses declared on specified dates, cash dividends paid during the term, and a terminal bonus conditional on the claim event. Adding the numbers in a projection is not enough. Each amount must be tested against its date, calculation basis, vesting rule, policy status, and eligibility conditions.
The checks in this tutorial concern the internal consistency of a projection under stated hypothetical product terms. They do not establish that future dividends or discretionary bonuses will be declared. In particular, an illustrated future amount must not be treated as an already vested guarantee unless the terms say it has been declared and vested.
A Practical Audit Sequence
Begin with the policy timeline, not the final total. Mark each policy anniversary, bonus declaration date, cash-dividend payment date, lapse or surrender date, and claim date. Then assess each projected component on that timeline. The product terms control whether a declaration is made at an anniversary, whether the policy must be in force on that date, and which claims receive a terminal bonus.
Record when each amount is declared or paid and whether the policy is in force and eligible on that date. Do not assume that a bonus scheduled for an anniversary is declared if the policy has ended before that anniversary.
Identify the quantity to which each rate applies: for example, original sum assured, the previous guaranteed benefit, or vested bonus additions. Use the basis specified for that component, not a convenient alternative.
Separate guaranteed basic benefits, declared and vested bonuses, conditional terminal bonuses, and cash dividends already paid. An illustrated future bonus is not automatically vested.
Apply the stated claim-event conditions, then sum only amounts payable at that claim. Show cash dividends paid earlier separately if reporting cumulative distributions.
A useful reconciliation for a claim amount is
This is a bookkeeping identity, not a universal product formula: the terms determine which components exist and are payable. Cash dividends already paid are not part of the claim benefit unless the contract specifically provides otherwise.
Checking Dates, Bases, and Vesting
A simple reversionary bonus is often expressed as a percentage of a specified fixed amount, such as the original sum assured. A compound reversionary bonus may instead be applied to the guaranteed benefit immediately before the new declaration. These methods produce different results, so the scale basis must be stated before calculating.
The compound formula follows directly from the scale definition. Immediately before declaration, the applicable base is \(G_{j-1}\). The bonus is the rate \(c_j\) times that base, so its amount is \(c_jG_{j-1}\). Adding it to the prior guaranteed benefit gives \(G_j=G_{j-1}+c_jG_{j-1}=(1+c_j)G_{j-1}\). If the scale instead specifies the original sum assured, this recurrence does not apply.
Vesting is a separate question from calculation. A projection might show a future bonus rate for illustration, but that does not by itself make the amount guaranteed. For this audit, treat a bonus as vested only when it has been declared and the stated terms make it guaranteed. A terminal bonus is usually assessed at claim and remains conditional on the specified event and policy status; the exact conditions are product-specific.
Worked Example: Death Claim After Three Declarations
Hypothetical terms. A policy has an original sum assured of $100,000. It receives a simple reversionary bonus of 3% of original sum assured at each policy anniversary, provided it is in force on that anniversary. Each declared bonus vests immediately. The policy remains in force through the third anniversary, and the insured dies six months later. A terminal bonus equal to 20% of vested reversionary additions is payable on death claims after the second anniversary. There is no cash dividend.
Method: audit each declaration date, then apply the claim condition. The policy is in force at anniversaries 1, 2, and 3, so all three declarations qualify. The scale is simple: each rate applies to $100,000, not to the benefit including earlier additions.
At each anniversary, the addition is \(0.03\times \$100{,}000=\$3{,}000\). The three additions are therefore $3,000, $3,000, and $3,000, giving vested reversionary additions of
The death occurs after the second anniversary, so the stated terminal-bonus condition is met. The terminal bonus is
The death benefit is the basic sum assured plus the vested additions plus the eligible terminal bonus:
Check. The three $3,000 additions total $9,000, and 20% of $9,000 is $1,800. The reconciled claim amount is $110,800. A common mistake is to calculate the simple annual bonuses on a growing benefit; that would use the wrong scale basis. Another is to include a fourth anniversary bonus, even though the death occurred before that date.
Cash Dividends and Compound Scales
A cash dividend and a reversionary bonus should not be merged merely because both arise under a participating policy. A cash dividend paid to the policyholder is a distribution, not automatically an addition to the guaranteed benefit. It affects a later bonus scale only if the stated scale explicitly includes it.
Worked Example: Compound Bonuses With a Cash Dividend
Hypothetical terms. A policy has an $80,000 basic guaranteed benefit. At each of the first two anniversaries, while in force, a 4% compound reversionary bonus is declared on the guaranteed benefit immediately before that declaration. Declared bonuses vest immediately. A $600 cash dividend is paid at the second anniversary under a cash option and is not reinvested. The policy remains in force after that date.
Method: update the guaranteed benefit at each declaration, keeping the cash payment separate. At the first anniversary, the scale base is $80,000. The bonus is
The guaranteed benefit after the first declaration is
At the second anniversary, the scale base is $83,200. Thus the second bonus is
Total vested additions are $3,200 + $3,328 = $6,528. The guaranteed benefit after the second declaration is $80,000 + $6,528 = $86,528. The $600 cash dividend is paid separately; it is not added to that benefit. Therefore, the guaranteed benefit is $86,528. If reporting the benefit plus the cash already received, the cumulative amount is $86,528 + $600 = $87,128.
Check. The second bonus is 4% of $83,200, which is $3,328, and the two additions total $6,528. A common mistake is to add the $600 cash payment to the compound scale base. The terms say the dividend is paid and not reinvested, so it neither increases the guaranteed benefit nor changes the second bonus calculation.
Reconciling Maturity Benefits and Prior Payments
For a maturity claim, verify that the policy is in force at maturity and that each scheduled declaration occurred before or at the relevant date under the stated terms. Then determine whether a terminal bonus applies to maturity, and identify its base precisely. A terminal bonus stated as a percentage of vested additions is not a percentage of the basic sum assured or the total maturity benefit.
Worked Example: Maturity With Simple Bonuses and Dividends Paid
Hypothetical terms. An endowment policy has a $50,000 basic maturity benefit. If in force, it receives a simple reversionary bonus of 2% of the original sum assured at each of anniversaries 1 through 4. Each declared addition vests immediately. At maturity on the fourth anniversary, a terminal bonus equal to 10% of vested reversionary additions is payable. Cash dividends of $500 were paid at anniversaries 2 and 3; they were taken in cash and do not form part of the maturity benefit. The policy remains in force until maturity.
Method: reconcile the maturity-date components and separately report prior cash payments. The policy qualifies for all four anniversary declarations. Each reversionary addition is
The four vested additions total \(4\times \$1{,}000=\$4{,}000\). The terminal-bonus base is those vested additions, so the terminal bonus is
The maturity benefit is therefore
The two earlier cash dividends total $500 + $500 = $1,000. They are not added to the maturity payment. If the requested measure is cumulative distributions including the previous cash dividends, the total is $54,400 + $1,000 = $55,400.
Check. The terminal bonus is $400 because its base is $4,000, not $50,000 or $54,000. A common mistake is to calculate 10% of the entire pre-terminal maturity benefit, producing an unsupported $5,400 terminal bonus. Another is to count the two cash dividends again as part of the maturity payment.
Common Audit Errors
A clean audit makes the basis and status of every amount visible. The following errors are especially consequential because they can produce a plausible-looking total while violating the stated terms.
| Audit question | Common error | Correction |
|---|---|---|
| Was the policy eligible on the declaration date? | Including a scheduled bonus after lapse or termination | Check status at each actual declaration date; include only qualifying declarations |
| What does the rate apply to? | Compounding a simple bonus, or applying a compound rate to the original sum assured | Use the scale base specified for that bonus |
| Is the amount vested? | Treating a future illustration as a guaranteed addition | Distinguish declared, vested amounts from projected discretionary amounts |
| Which claim event qualifies? | Including a maturity-only terminal bonus on death, or vice versa | Test the actual claim event and all stated eligibility conditions |
| Was a dividend already paid? | Adding a cash dividend to the claim benefit or to a bonus base without authority | Show prior cash distributions separately unless the terms direct otherwise |
The final check is arithmetic and conceptual: every amount in the claim total should be traceable to a date, a calculation basis, and an eligibility rule. If an amount cannot be assigned to all three, it should not be silently included.
Check Your Understanding
For each hypothetical set of terms, audit the relevant amounts and compare your result with the answer.
- A $60,000 policy remains in force through maturity at the end of year 3. It receives a simple bonus of 1.5% of original sum assured at each anniversary, and each declaration vests. A maturity terminal bonus is 25% of vested additions. What is the maturity benefit? (Answer: $63,375)
- A $40,000 policy receives compound bonuses of 3% of the previous guaranteed benefit at the ends of years 1 and 2. Both bonuses vest. A $200 cash dividend is paid at the end of year 2 and is not reinvested. What is the guaranteed benefit after the second declaration, and what is that benefit plus the cash dividend? (Answer: $42,436; $42,636)
- A $90,000 policy receives simple bonuses of 2% of original sum assured at the ends of years 1 and 2. The insured dies after the second anniversary but before the third. A death terminal bonus is 12% of vested additions. What is the death benefit? (Answer: $94,032)
- A $70,000 policy receives compound bonuses of 5% of the previous guaranteed benefit at the ends of years 1 and 2. It lapses immediately before the third anniversary. The terms say vested additions remain payable on an eligible claim after lapse, but no later bonuses are declared. What is the vested amount carried forward at lapse? (Answer: $77,175)
- A $75,000 policy receives simple bonuses of 3% of original sum assured at the ends of years 1 and 2. Death occurs one day before the third anniversary. A death terminal bonus is 20% of vested additions. What is the death benefit, assuming the policy is in force at death? (Answer: $80,400)