Chapter 12-Analysis of change in Embedded Value

Question 1

Outline the reasons for analyzing the change in embedded value? (8)

Answer 1

• Checking the calculation of EV
• Assist in revision of assumptions
• Provide management the information of the value of new business
• Identify sources of EV profit and loss such that management action can be taken
• Identify unprofitable contracts so that they can redesigned, re-priced or cancelled
• Improve management understanding of the business
• Assist in calculation of management incentive schemes
• Provide investment analyst the true underlying source of additional value

Question 2

Outline how a change in embedded value analysis is conducted? (8)

Answer 2

• The three components of embedded value should be analysed separately
o Change in adjusted net worth (analysed according to chapter 11)
o Change in PVIF
o Change in CoRC

• VIF1 (expected) = VIF0 + VIF0*RDR – expected after-tax profit
VIF1 (expected) = VIF0 + [unwind of RDR] – [profit transfer to ANW]

• The expected after tax profit should have an offsetting effect (positive value) in ANW column
• VIF1 (actual) = VIF1 (expected) + [experience variances] + [assumption changes] + [impact from VNB]

•	The difference between PVIF1 (actual) and PVIF1 (expected) can mainly be ascribed to the following:
o	Value of new business
o	Operating experience variances
o	Operating assumption changes
o	Investment return variance
o	Economic assumption change

• Experience variances (impact thereof):
o recalculate the year-end VIF by changing each underlying factor from expected to actual one at a time, and take the change in value

• Assumption changes (impact thereof):
o calculate year-end VIF using [start of year] and [end of year bases], and take the change in value

• VNB should be determined at point of sale
o And then analyse the change in the value from point of sale to the valuation date
o VNB also contribute to: unwind of RDR, expected profit transfer, experience variances, assumption/model changes

Question 3

Describe how an AoEV can be used in contract design and pricing? (3)

Answer 3

• The new business analysis in the product will usually be split by the type of contract indicating a contribution to the value of new business of each product which can be used to evaluate the profitability of various products
• The operating experience variance may reflect trends indicating that the contract design or pricing should be changed
• Where valuation methodologies are the same the net worth component of the analysis should be the same in the change in EV and the analysis of surplus (difference may arise due to difference in economic assumptions)

Question 4

Outline the advantage of analysis of embeded value over analysis of surplus? (3)

Answer 4

• Impact on future years’ profits (through VIF) is also considered and not only the current year’s profits
o More complete picture

• Margins in the liability basis usually have a minor impact on the EV experience as margins are expected to be released as future profits, which is allowed for in the analysis
o For AoS – release of margins comes through as surplus
o For EV – release of margins is surplus in ∆ANW, but reduced in ∆VIF  margins have small impact

• CoRC is allowed for.
o Specifically cost for VNB
o CoRC have significant impact on profitability

Question 5

outline the expected profit transfer line in AoEV? (3)

Answer 5

• Profits expected to emerge from existing business
• Once earned, come out of PVIF and fall into ANW  no change in overall EV

-	Expected net CF on beginning year assumptions
o	E(premiums) –E(claims) – E(expenses) + E(change in reserve) + E(interest)

Question 6

outline expected return on covered business? (4)

Answer 6

• Change in VIF and CoRC, if actual experience followed assumptions
  o Change in VIF before surplus distribution
• Change in VIF represents: unwind of RDR on opening PVIF
  o = RDR* VIF0
• APN107: preferably include expected return on NB from point of sale to calc date
  o But, can group expected return on NB with VNB

Question 7

outline investment return variances? (4)

Answer 7

• AvE of investment return
• [current-] & [PV of future-] profit/loss from sh share of investment returns – different from expected
• Includes changes in eco variables (interest/infl), beyond control of mngmt – where these are reflected in A values
• Show separately for ANW & IF
• PVIF: reflects impact of AvE achieved on PH assets
• ANW: “” achieved on assets backing the ANW
• Mismatch A&Ls  mismatch profits different than expected

Question 8

outline operating variances return variances? (4)

Answer 8

• AvE from non-eco experience
• [current-] & [PV of future-] profit/loss from sh share of non-eco experience – different from expected
• Mortality, lapses, PUPs, expenses
• The underlying items may be offsetting each other
• To check – need this item split by type of experience variance

o Then check it against sensitivities to assumption changes

-	Eg, Premium variation
o	AvE from premium income
o	Result from 
	Lapses different than expected!
	Active policies’ premiums are outdated
	Anticipated premium increases are different than expected
	Premium dept written off