Chapter 19 Supervisory reserves and capital requirements (1) Flashcards
What 2 primary methods can be used for reserve calculations? (2,1)
The two primary reserving methods are
Gross premium valuation method
under unit-linked busines, special case of the gross premum arises
where valuation of future non-unit cashflows may need a seperate method to identify and reserve for future negative CFs
Net premium valuation method
Define the gross premium valution method ( 3 )
Calculates value of a life insurance company’s liabilities that explicitly takes into account
the future office premiums payable
expenses & claims (potentially including future discretionary bens)
Reserves = PV(expected future benefit outgo) + PV(expected future expenses) - PV(expectd future office premiums)
Gross premium vln mthd: unit-linked reserves
List the 2 key components of the liability that must be considered when valuing a unit-linked policy (2)
- unit-reserve
part of reserve insurer sets up for its unitised contracts
represents liability in terms of the units held under these unitised contracts
calculated as number of units x ‘bid price’ of units i.e. price insurer is contractually obliged to buy units off policyholders - non-unit reserves
part of reserve insurer sets up for its unitised contracts
represents liabitlies other than that attributed to the unit reserve e.g. future expenses and mortality costs etc
Explain why a positive non-unit reserve may be required for a prudential valuation of a unit-linked contract (2)
Life company will receive monetary payments in form of policy charges to cover non-unit liabilities…
…eg expenses of managing business..
…or benefit payments in excess of the unit fund
If it expects the charges will not be sufficient to cover these liabilities at any point on a cashflow basis, it has to hold a non-unit reserve to provide for the deficiency
Describe how to calculate a non-unit reserve for a
prudential valuation (8)
- Model projected non-unit CFs on reserving basis (may need per policy)
- Identify last net cashflow whether positive or negative (allowing for discounting and survival)
- Reserve = amount at start of that period which is sufficient, allowing for earned investment return over the period, to ‘zeroise’ that cashflow
- Check that total reserve (unit + non-unit) > guaranteed surrender value i.e unit reserves less surrender penalty
- Move back to next previous CF, discount the reserve and then subtract from the reserve the new cashflow at the earlier time period. Repeat step above.
- Carry on repeating process working backwards over time to valuation date.
Explain when a negative non-unit reserve may arise (1)
Describe some other features related to negative non-unit reserves (4)
- Negative non-unit reserves may arise when
the life insurance company anticipates that future charges will be more than sufficient to meet future non-unit liabilities
- A few other general points about negative non unit reserves
represent a loan from other contracts which have positive reserves, which will be repaid by emerging future profits from policy for which negative non unit reserve is held (simply taking credit for future profits from a policy)
improves capital effeciency, since it reduces total reserve under policy
used, in theory, whenever there are future positive CFs the company would like to take advance credit for (be careful not to take too much credit)
needs adequate surrender penalty, to ensure value of future CFs not lost if PH withdraws
How would we define the Net Premium Valuation method? (4)
Net Premium Valuation method is essentially
- PV of expected future benefit outgo, less PV expected future net premiums
- calcultd on interest & mortality basis only ie no explicit expense allowance
- benefit ougto includes bonuses declared to date, no explicit allowance for future bonuses
- net premium is premium insurer would charge from pol inception to cover initial guaranteed benefits only (so again, expenses are ignored), assuming the same basis as used for PVs (so this may not be same as original pricing basis
