Chapter 23 : Supervisory Reserves and Capital Requirements (1) Flashcards
What is the purpose of reserves? (i.e. valuing the assets and liabilities of a life company)
- To demonstrate solvency to the supervisory authorities
- To investigate realistic/”the true” position of the life company
What are some features of the gross premium method?
- An explicit allowance for expenses
- An explicit allowance for vested and expected future bonuses
- Future premiums are valued at the actual office premiums expected.
- Any differences in pricing and valuation are immediately taken as a profit or loss
- Reserves may initially be negative for non-linked due to initial expenses
- Reserves are sensitive to a change in basis
What are some features of the net premium method?
- It is simple
- It makes no explicit allowant for future expenses
- It makes no explicit allowance for future bonuses
- For regular premium business, the reserves are relatively insensitive to changes in the valuation basis.
What is a negative non-unit reserve?
We can hold a negative non-unit reserve under a contract where future non-unit income (future charges) are expected to be more than sufficient to meet future non-unit outgo.
We reduce the total reserves by taking advance credit for the EPV (future positive cashflows)
Reserve= loan from contracts with positive non-unit reserves
Loan is repaid by the emerging future profits
What are the constraints on negative non-unit reserves?
FP3 RS2
1.R: Local regulation
2.S: Sum of unit and non-unit reserves should not be less than any guaranteed surrender value
3.P: There should be adequate non-unit surrender penalties to ensure that the value of the future cashflows is not lost on a surrender
4. P: Future profits need to emerge in time to pay the loan
5. F: Taking account of the negative non-unit reserve should not lead to future negative cashflows (no valuation strain)
6. S: Sum of all non-unit reserves should not be negative
7. P: Negative non-unit reserves should be determined prudently
How do we calculate negative non-unit reserves?
- Project the expected future non-unit cashflows (income charges less outgo)
2.Identify most distant cashflow - Set the reserve as an amount needed to meet the cashflow
- Check that total reserve>surrender value
- Move back to previous cashflow, discount reserve and subtract new cashflow for earlier time.
- Carry on process working back to valuation date.