Chapter 23 Flashcards
What are the two fundamentally different purposes for valuing assets and liabilities?
- Demonstrate solvency to supervisory authorities
Involves a minimum valuation standard
May require that prudent assumptions are used to make the chance of failing to meet liabilities acceptably small - Investigate realistic/”true” position of the life company
For internal management purposes to give a picture undistorted by various margins inherent in the solvency valuation
What are the typical uses of determining the realistic position of the life insurance company?
- Help determine the LT sustainability of profit distribution rates and hence determine the current bonus declarations.
- Help determine the realistic profitability of the company for the information of shareholders and management.
- Assist in general financial management of the life company.
What are the 2 primary reserving methods?
- Gross premium valuation method
- Net premium valuation method
The GPV method is a method for placing value on LIC’s liabilities that explicitly values:
- Office premiums payable
- Expenses
- Claims
How is the reserve calculated under the GPV method?
(PV of expected future benefit outgo) + (PV of expected future expenses) - (PV of expected future premiums)
What are the different approaches under the GPV method?
The CF approach and the formula approach
How does the CF approach work under the GPV method?
The net CFs are calculated for each future point in time and discounted back.
What may prudence in reserves lead to?
It may lead to reserves being positive even at policy commencement.
What is the normal trend for reserves?
The normal trend is for reserves to start negative and progress smoothly into the policy benefit.
How does the structure of a UL contract work with regards to the company’s liabilities?
It is such that the company’s liability is denominated partly in terms of units and partly monetary terms.
What are some of the non-unit liabilities?
- Admin expenses
- Mortality costs if not all paid for by unit deductions
- Future cost of guarantees
- Future guarantee subsidy of allocation rate if not covered by margins in unit pricing
Define the unit reserve.
The part of the reserve that the LIC needs to set up in respect of unitised contracts. It represents the liability in terms of the units held under the unitised contracts.
How will the unit reserve be calculated?
The number of units multiplied by the bid value of the units.
Define the non-unit reserve.
The PV of the excess of the non-unit outgo over the non-unit income.
How is the non-unit reserve defined in a prudential valuation?
It is defined as the amount required to ensure that the company can pay claims and meet its continuing expenses without recourse to future finance.
How is the non-unit reserve defined in a best estimate valuation?
It is the value of all the future non-unit CFs - would not disregard the CFs occurring after the last projection period in which there is a net outflow
What is a negative non-unit reserve?
It represents a loan from other contracts which have positive non-unit reserves. The loan will be repaid by emerging future profits from the policy for which the negative non-unit reserve is held.
What is the purpose of negative non-unit reserves?
It may be used to take advance credit for future excess positive CFs to reduce the capital strain in a prudential valuation.
What are some of the regulations with regards to negative non-unit reserves?
- Negative non-unit reserves may not be permitted in some regulatory regimes.
- Sum of the unit and non-unit reserves may not be less than the SV.
- Future profits on policies with negative non-unit reserves must arise early enough to repay the “loan”.
- No future negative CFs after allowing for the non-unit reserves.
- The sum of the non-unit reserves may not be negative - regulations might state that the negative reserves cannot be offset against unit reserves.
What is the impact of negative non-unit reserves on the total reserves?
It reduces the total reserve under a contract and hence improves the capital efficiency of the product.
Is it possible to make a future loss if you make use of negative non-unit reserves?
Yes, therefore the negative non-unit reserves should not be too big.
How will a prudent approach work for the non-unit reserve?
- Calculate future positive CFs to be lower than best estimate.
- The rate of interest used to discount CFs should be higher than best estimate for negative non-unit reserves.
- The rate of interest used to discount CFs should be lower than best estimate for positive non-unit reserves.
- The survival rates should be lower than best estimate.
What are the important features of the GPV method?
- Explicit allowance is made for expenses.
- Explicit allowance can be made for vested and expected future business.
- Future premiums valued are the actual premiums expected.
- The difference in the pricing and valuation bases will immediately be taken as a profit or a loss.
- Reserves may initially be negative for non-linked business partly due to initial expenses and capitalising expected future profit.
- Reserves tend to be quite sensitive to changes in basis.
How is the reserve calculated under the net premium valuation method?
(PV of expected future benefit outgo) - (PV of future net premiums)
