APN110 (Allowance for embedded inv derivatives)

Question 1

What does it recommend the use of

Answer 1

MC BE stochatic models to quantify the reserves required to finance projected shortfalls

Question 2

What assumptions need to be made

Answer 2

-rfr from gov bond/Swap YC
-volatilities should be in line with those implied by traded derivatives with appropriate underlying assets
-tax

Question 3

What are the real world model shortcomings

Answer 3

1) it takes credit for risk premia on risky asset classes and hence is not arbitrage free
2) historical data does not necessarily represent the future

Question 4

Advantages of market consistent models

Answer 4

1) they product arbitrage free returns - ensures that the value placed on IGR is unique and independent of backing assets
2) objective - assumptions are derived from market prices

Question 5

In calculating the IGR for smooth bonus business, what do you need to project

Answer 5

1) EAS - allowing for actual projected IR and premium patterns
2) PH liabilities allowing for projected bonuses
-also make allowance for guaranteed bonuses

Question 6

What are the two levels of guarantees

Answer 6

• GMV > PH Ls
• PH Ls > EAS

Question 7

What is diff between smooth bonus and conv WP reserve

Answer 7

Conv WP guarantee is basic sum assured plus declared bonuses. IGR is then difference between EAS and guarantee