Ch23: Supervisory reserves and capital requirements (1)

Question 1

Two fundamentally different purposes for valuing the assets and liabilities of a company

Answer 1

1. to demonstrate solvency to the supervisory authorities
2. to investigate the realistic position of the company

Question 2

Reserving methods

Answer 2

• gross premium valuation
• net premium valuation

Question 3

Calculation of the non-unit reseve

Answer 3

• the calculation starts with the last projection period in which the cashflow becomes negative
• an amount is set up at the start of that period which is sufficient, allowing for earned investment return over the period, to zeroise the negative cashflow
• this amount is then deducted from the net cashflow at the end of the previous time period
• the process continues to work backwards to the valuation date, which each negative being zeroised in this way
• when the process has been completed, if the adjusted cashflow at the valuation date is negative, then a non-unit reserve is set up equal to the absolute value of that negative amount

Question 4

What may regulation specify in terms of negative non-unit reserves

Answer 4

• the sum of the unit and non-unit reserves for a policy should not be less than any guaranteed surrender value
• the future profit arising on the policy with the negative non-unit reserve need to emerge in time to repay the loan
• in aggregate, the sum of all non-unit reserves should not be negative
• after taking account of the future non-unit reserves, there are no future negative cashflows for the policy

Question 5

Calculating negative non-unit reserves

Answer 5

1. project the expected future non-unit cashflow from the policy, i.e. income from charges less outgo
2. identify the last cashflow
3. set the reserve as the amount needed to meet that cashflow at that point in time
4. check that the total reserve is greater than the surrender value
5. move back to the next previous cashflow, discount the reserve and then subtract from the reserve the new cashflow. Repeat step 4
6. carry on repeating the process working backwards over time to the valuation date
7. this will give the required non-unit reserve

Question 6

Features of gross premium method

Answer 6

• an explicit allowance is made for expenses
• an explicit allowance can be made for vested and expected future bonuses
• the future premiums valued are the actual office premiums expected
• any difference between the pricing and valuation base will immediately be taken as profit
• reserves may initially be negative for non-linked business, partly due to initial expenses and partly due to capitalising the expected future profit
• the reserves tend to be quite sensitive to changes in basis

Question 7

Features of net premium method

Answer 7

• it is simple
• it makes no explicit allowance for future expenses
• it makes no explicit allowance for future bonuses
• for regular premium business, the reserves are relatively insensitive to changes in the valuation basis