Ch 23: Supervisory reserves and cap reqs (1)

Question 1

Uses of a “True”/realistic valuation

Answer 1

• Determine long-term sustainability of profit distribution rates (such as bonuses) and hence help to determine current bonus declarations
• Help determine the realistic profitability of the company for info to shareholders and management
• Assist in the general financial management of a life company

Question 2

Gross premium valuation definition

Answer 2

Method for placing a value on a life insurance company’s liabilities that explicitly values for future office premiums payable, expenses and claims.

Question 3

Non-unit reserves definition:

Answer 3

• PV of excess of non-unit outgo (expenses, benefits in excess of unit fund) over non-unit income (charges, unallocated premiums).
• Discounted cashflow method is used

Question 4

Non-unit reserves - prudential valuation:

Answer 4

• In this case, not-unit reserve defined as the amount required to ensure that the company is able to pay claims and meet its continuing expenses without having to find further funds.
• Necessary then to calcuate the reserve on a year-to-year basis to determine if and when a non-unit reserve is required.
• Non-unit cashflows are projected forward on the reserving basis
• Calculation:
  * Calc starts with the last projection period in which the net cashflow is negative
  * An amount is set up at the start of that period which is sufficient (allowing for investment return earned over the period) to “zerorise” the negative cashflow
  * This amount is then deducted from from te net cashflow at the end of the previous time period
  * Process continues to work backwards towards the valuation date, with each negative being zeroised in this way
  * When the process is completed, if adjusted cashflow at valuation date is negative then a non-unit reserve equal to the absolute value of that amount is set up.

Question 5

Non-unit reserves - best estimate valuation

Answer 5

• Calculation would value all future non-unit cashflows (would not ignore cashflows occuring after the last projection year in which there is a net outflow) and there would be no other restrictions.

Question 6

When is it allowed to hold a negative non-unit reserve?

Answer 6

• Depends on regulations which may specify that:
  * Sum of unit and non-unit reserves may not be less that any guaranteed surrender value
  * After taking account of future non-unit reserves, there should be no further negative cahsflows for the policy
  * In aggregate, sum of all non-unit reserves should not be negative

Question 7

Calculating negative non-unit reserves

Answer 7

• Project expected future non-unit cashflows
• Identify most distant cashflow (positive or negative)
• Set reserve as an amount needed to meet that cashflow at that point in time (even if cashflow is net inflow, set up a negative amount)
• Check that the total reserve (unit + non-unit) is greater than the surrender value (unit reserve - surrender penalty)
• Move back to previous cashflow, discount the reserve and then subtract from the reserve the new cashflow at the earlier time period
• Repeat until valuation date is reached
• This will give required non-unit reserve

Question 8

Prudency in negative non-unit reserves

Answer 8

• Future positive cashflows discounted at a higher than best estimate rate and survival rates are lower than best estimates

Question 9

Features of the gross premium method to calculate reserves

Answer 9

• Explicit allowance made for expenses
• Explicit allowance made for vestd and expected future bonuses
• Future premiums valued are actual office premiums expected
• Any differences between pricing and valuation bases will immediately be taken as profit or loss
• reserves may initially be negative for non-linked business, partly due to initial expenses and partly due to capitalising expected future profit
• Reserves quite sensitive to changes in basis

Question 10

Net premium valuation method features

Answer 10

• It is simple in terms of formula used and data required
• Implicit level allowance for future expenses
• implicit level allowance for future bonuses
• not appropriate for single premium business without adjustement
• for regular premium business, reserves are relatively insensitive to changes in the valuation basis
• mainly used for conventional with-profits, does not capitalise profit margins in future gross premiums.

Question 11

Net premium valuation method definition

Answer 11

PV of expected future benefit outgo less PV of future net premiums (on basis of interest and mortality only)

Question 12

Net premium def in net premium val method definition

Answer 12

• Premium the company would charge from policy inception to cover initial guaranteed benefits only (no expenses) assuming the same basis as used for the PVs in the reserve calc (i.e. prob not the same as the original pricing basis)