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

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

Answer 2

• 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 3

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

Answer 3

• 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 4

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

Answer 4

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

Question 5

outline expected return on covered business? (4)

Answer 5

• 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