Chapter 17 Flashcards
The premiums of a unit-linked contract are partly allocated to:
UF: used to purchase units in an investment fund
Non-UF: initial charges (cover high initial expenses), regular charges (AFMC) and unallocated premium on policy accrue here
How were the high initial costs on a unit-linked policy funded in the past?
By varying the allocation % - lower % during the early years of the policy but this is not consistent with PRE
How does actuarial funding work?
- The company buys fewer units than it should when premiums are received and then uses some of the future FMC to buy back the missing units over time.
- The company is taking credit at inception for some of the future charges by allocating less money to the PH’s unit account at inception.
- By anticipating FMC, bringing forward the positive CFs, we produce a better match for initial expenses.
- Used as an alternative to having very low or zero initial allocation rates which are unattractive to PHs.
What is the “mismatch” between income and outgo referred to for which actuarial funding is a solution?
- There is a large outgo at the start of the policy whereas the income to cover it is received regularly over the term of the policy.
- This produces a large initial capital strain when a policy is sold.
What is the purpose of actuarial funding?
It is a technique whereby LICs can hold lower reserves for UL contracts and thus reduce the NBS.
For which product designs are actuarial funding useful?
- Products with high regular FMCs used primarily as a means of recouping initial expenses.
- There is no explicit initial charge, only regular FMCs.
- A surrender penalty exists.
What are the necessary conditions for actuarial funding to work?
- UF benefits must be contingent on death or survival for a minimum period of years.
- Sufficient regular FMCs available.
- Unit-related SP imposed such that the unit reserve is not lower than the SV payable.
- Stable mortality experience preferred.
How does capital and accumulation units work?
- Capital units: apply first one- or two-years’ premiums to purchase capital units - involve high FMCs, which will allow us to use actuarial funding. No longer common due to the lack of transparency to the PH.
- Accumulation units: Most of the premium used to by units in the UF.
When is the UF fully funded?
If investments are held which exactly match the bid value of the units purchased by the allocated premiums.
Since the LIC’s liabilities are contingent on death or survival, it is reasonable to …
hold the actuarial PV of the UF rather than the fully funded value.
What is the actuarial PV for a UL endowment assurance at time t?
The fully funded value of the UF at time t multiplied by the endowment assurance factor of age x+t and term n-t.
What basis will be used to calculate the actuarial funded PV?
- Annual interest rate: approximately equal to the amount of annual FMC that company wishes to pre-fund.
- The valuation mortality basis is used for calculating the funding factors.
What is the net CF that will emerge from the UF on the allocation of each premium?
It will be equal to the difference between the premium paid and the actuarially funded value of the units purchased.
What is the residual net CF that will emerge at the end of each year?
It is the actuarial funded PV at time t-1 accumulated at the unit growth rate for 1 year, minus the actuarial funded PV at time t, minus the difference between the fully funded value at time t and the actuarial funded PV at time t, multiplied by the probability of dying between time t-1 and time t.
What is the effect of the increased positive net non-unit fund CFs?
It reduces the NBS and the cost of capital required to issue a policy.
How does actuarial funding reduce the NBS?
- It allows the company to hold lower fund value reserves for UL business - done by holding the actuarial PV of the fund on death.
- The difference between the fully funded value and the actuarial PV is transferred to the non-unit fund and utilised to cover high initial expenses.
- The LIC more appropriately matches the timing of its income and expense outgo by swapping regular management charge income for a higher initial income.
- Only possible if the regular FMCs are high enough.
What are the risks of actuarial funding?
- Risk of loss if actual mortality is higher than assumed in calculation of funding factors.
- There is no investment risk because the liability to buy “lost” units in the future is exactly matched by the future FMCs.
- The SV must not be higher than the actuarially funded value of units held, otherwise financial risk will arise from withdrawals.
Provide a summary of the CFs between the UF and non-unit fund.
● A CF from the unit to the non-unit fund of the difference between fully funded and actuarially funded units on each unit purchase.
● A CF from the unit to the non-unit fund of the charge on the units but followed at the same time by a CF from the non-unit to the unit fund to build up the (increasing number of) actuarially funded capital units required at the year-end. (Releasing of reserves…)
● A CF from the non-unit fund on deaths to meet the cost of the excess of guaranteed minimum sum assured over the value of units held by the company.
● A CF to the non-unit fund on surrender equal to any excess of the value of units actually held by the company over the SV granted.
