experience profits and losses are small relative to planned profit emergence so profit reporting results should be relatively smooth. However, because assets are valued at market, then there is an element of variability from investment market volatility and this is the main cause of experience profits or losses (see below regarding updating profit margins).

A key principle is that profits are earned in a manner that is neither deferred nor prematurely recognized. The choice of the profit carrier is critical to this outcome. Profits are to be earned on the later of the provision of the service and the receipt of the income relating to the service. In the case of annuities, this would always be the provision of the service given that all premiums are received at inception of the contract.

As noted above, although profits are recognized over the life of the contract, losses tend to be recognized immediately. The effect of this obligation is to strongly discourage loss making pricing even in the short term. Although pricing is not regulated directly, companies are obliged to obtain actuarial advice on pricing and the supervisor can determine, from the reports on experience profits and losses and the actuarial financial condition report, whether prices are considered sustainable.

As experience emerges, the actuary determines if the change compared to the assumptions is transitory or expected to be a permanent feature in future. Where it is transitory, the effect of the favorable or unfavorable experience will be reflected in the current year profit (particularly the experience profit). Where the change is permanent, the effect is reflected in a change in the profit margin. When adverse, the profit margin is reduced and the present value of future profit margins is reduced correspondingly. The result, in such a case, is that the effect of the change emerges over the life of the contract as the now lower profit margin emerges. When sufficiently adverse to lead to the profit margin becoming negative then, as the PVPM cannot be negative (treated as an asset) the losses are capitalized and reflected immediately. A third case, when previous considerations have led to negative profit margins but this adversity is now considered to be less severe, is treated as a special case. The profit can emerge immediately up to the point when the profit margin becomes positive again when it is reflected and emerges through the profit carrier mechanism once again. Profits can be ‘released’ to the extent that previously recognized losses have been recognized.

Although of limited practical relevance to annuities as the volumes are small, provision is made for participating contracts. In this case, the liability separates the future profits between the expected bonuses and the expected shareholder component of these profits.

With respect to annuities, one normal profit carrier is the payment of annuity benefits. This means that the profits emerge in proportion to the actual annuity payments. The service of establishing the contract is permitted as a secondary profit carrier however caution is expressed in the standards about more than one profit carrier to ensure that profit is not realized and released prematurely. Once chosen, the profit carrier has to be used consistently so the decision is somewhat ‘cast in stone’. Even if a profit carrier is changed along the way, the profit margins are recalculated so that no profit release takes place as a result of the change itself.

The consequence of these rules is that annuity profits emerge largely over time as the annuity payments are made, that the provision includes allowance for taxes and expenses as well as benefits on a ‘best estimate’ basis plus the emergence of a profit on the 34