CH 17 (Actuarial Funding)

Question 1

Adjusted Reserve Formula

Answer 1

Normal Reserve

- EPV[Initial Expense Charges]

Question 2

Purpose of Actuarial Funding

Answer 2

1. Reduce NBS (lower reserves)

2. Reduce mismatching risk
(timing mismatch
[initial expense vs subsequent charges] 
\+ 
nature mismatch
[investment risk])

Question 3

Two Types of Units

Answer 3

• Capital/Initial Units
  (units bought in initial year that attracts higher charge)
• Accumulation/Ordinary Units
  (units bought thereafter attracting lower management charge)

Question 4

Limitations of Actuarial Funding

Answer 4

• Management charges

- Surrender benefit

Question 5

Requirements for Actuarial Funding

Answer 5

SPACD

• unit-related Surrender penalty imposed (unit reserve can’t be lower than surrender value)
• after actuarial funding, prudently projected future net CFs to insurer must remain Positive
• Allowed by regulation
• sufficient regular fund management Charges available.
• unit fund benefits must be contingent on Death and on survival for minimum period of years

Question 6

Cashflows with Actuarial Funding

Answer 6

• Difference between fully funded units and actuarially funded units
  (unit fund to non-unit fund)
• Reduced charge on units
  (unit fund to non-unit fund)
• Build-up of actuarially funded capital units required at year end
  (non-unit to unit fund)
• Cost of the excess of guaranteed min Sum Assured over value of units
  (non-unit payment)
• Excess of value of units actually held by company over surrender value at points of surrender
  (unit fund to non-unit fund)

Question 7

Define Actuarial Funding

Answer 7

1. Context of unit-linked contracts
2. Actuarial funding is when insurer takes credit for some of the future annual management charges in present day terms
3. Insurers can hold lower reserves
4. Reduces new business strain
5. Money saved can be used to cover initial expenses
6. Missing unit funds can then be bought later from future management charges
7. Management charge should thus be greater than actual fund management expenses

Question 8

Advantages of Actuarial Funding

Answer 8

1. Lower reserves
   > Reduced NBS
   » Can write more business
   » Can be more capital efficient
2. Better matching between charges and expenses…
3. …without having to impose a zero allocation to units for the policyholder to meet the expenses
   > Improved marketability
4. Reduced investment risk and persistency risk
   (because of better matching)

Question 9

Disadvantages of Actuarial Funding

Answer 9

1. Regulatory restrictions
2. Can be complicated
   (esp. if used with capital units)
   > Reduced transparency
   > Poor persistency because clients not understanding products
   > Restricts distribution channels + More effort required to sell
   » May restrict level of sales
3. Requires surrender penalty
   > May be unattractive
4. Increase mortality risk
   (Sum at risk will be higher due to greater discrepancy between reserves held and face value of units)