23 + 24. Reserves II - Negative non-unit reserves

Question 1

How do negative non-unit reserves arise?

Answer 1

• Future non-unit expected income > expected outgo
• They can be seen as a “loan” from contracts with positive non-unit reserves repaid by emerging profits from contracts with negative reserves

Question 2

How do negative non-unit reserves reduce new business strain?

Answer 2

• The company’s liabilitiesare reduced by negative non-unit reserves that are subtracted, so taking credit for future cashflows

Question 3

How do you calculate negative non-unit reserves?

Answer 3

1. Project the expected cashflows
2. Identify the last cashflow
3. Reserve is the amount needed to meet the cashflow at that time.
4. Check that the reserve is not less than the surrender value
5. Move to the next previous cashflow, discount the reserve above and subtract it from the cashflow.
6. Continue until the valuation date.

Question 4

When can they be held?

Answer 4

If allowed by regulation

Question 5

How can regulation be applied to negative non-unit reserves?

Answer 5

1. The sum of the unit and non-unit serves should not be less than any guaranteed surrender values.
2. The future profits from the contracts with negative reserves must emerge in time to pay off the “loan”
3. The sum of the non-unit reserves should not be negative.
4. After accounting for future non-unit reserves, there should be no future negative cashflows for the policy, i.e. no future valuation strain.
5. Not being allowed to be used to offset unit reserves
6. Assumptions must be prudent and not too aggressive

Question 6

How would negative non-unit reserves work on a prudent basis?

Answer 6

• Not too big in absolute terms
• Assume positive cashflows are less than best estimate
• Assume interest rate is higher “ “ “
• Assume mortality is higher “ “ “

Main point:
Don’t take too much credit for future cashflows