CH 16 (Pricing Units) Flashcards
Two Key Principles of Pricing Units
- Unit price is the value of the asset pool divided by the number of units
(prices should only depend on backing asset performance and deductible charges) - Equity principle
(the interests of unit holders not involved in a unit transaction should be unaffected by that transaction)
**Creation/Cancellation of units should not give rise to change in NAV per unit
Management Box Concept
Units created in excess of liabilities to facilitate the management of a fund
(dealing with influxes in demand)
Two Pricing Bases
- Appropriation Price
(paid on creation of unit;
NAV of a unit under offer basis) - Expropriation price
(realised on cancellation of a unit; NAV of a unit under bid basis)
Two Categories of Fund Growth
- Expanding fund
(net creator of units
–> Value on offer basis
–> Money put into fund
= net no. units created
x appropriation price) - Contracting fund
(net canceller of units
–> Value on bid basis
–> Money put into fund
= net no. units cancelled
x expropriation price)
*Basis likely to only change if significant movement against existing basis
(=broad equity approach)
3 Contexts of “bid” and “offer”
- Buying and Selling Prices of Assets
- Buying and Selling Prices of Units
- Pricing basis of units
Appropriation Price Calculation
[ Market offer price
+Purchase expenses
(incl tax)
+Value of current assets
-Value of current liabilities
+Accrued income
-Accrued expenses (tax) ]
/
[ Number of units ]
(if not divided by units, then just NAV of fund under offer basis)
Two Types of Adjustments to Unit Prices
- Initial charges
= bid offer spread
(
**Charge to contribute to initial expenses, incl. commission and possibly profit
**offer price =
purchase price under basis + initial charge
**bid price = purchase price under basis
…if fund is expanding, purchase price will be guided by market offer basis.
If fund is contracting, purchase price will be guided by market bid basis)
- Rounding
(certain number of decimal places
–> Can be in favour of customer or insurer)
Main Risks with Unit Pricing
A(MTV) A(TA) E(BED) R R A PS
- underlying Assets
> perfect Matching likely not possible because liability will be dependent on unit price
> Timing delays (price risks)
> Volatility of underlying assets - Approximations in price
> Tax on unrealised capital gains
> Accrued (but not realised) assets and liabilities (e.g. accrued interest not yet received) - Errors in actual calculations
> appropriation/expropriation Basis (risk of wrong basis to calculate UP)
> Error in calculation routine
> price based on incorrect Data - Regulations restricting policy charges (may be included in price and changes will pose a risk)
- negative impact on Reputation
(will affect new business and withdrawals) - negative impact on company Profits
> because charges are based on the value of units
> company expected to make up Shortfall in benefits resulting from pricing error - Anti-selection
(policyholders selectively disinvesting if aware that UP overstates NAV)
Difference of expropriation price calculation from appropriation price
Starting point:
= Proceeds that would be received from selling assets in the fund
Requires that investments are valued on market bid basis and expenses incurred during sale are deducted from the fund
Considerations for charges on unit-linked fund
Items the charges are to cover:
> Expenses (initial, renewal, termination)
> Cost of capital
> Profit
>Guarantees (death/maturity)
Timing and size of charges
> Charges start low and grow as fund increases
> Difficult to match initial expenses since low at outset
Charge calculation:
> Fixed amount or related to fund value?
> If related to fund value, exposes company to market risk
