Chapter 23 : Supervisory Reserves and Capital Requirements (1)

Question 1

What is the purpose of reserves? (i.e. valuing the assets and liabilities of a life company)

Answer 1

1. To demonstrate solvency to the supervisory authorities
2. To investigate realistic/”the true” position of the life company

Question 2

What are some features of the gross premium method?

Answer 2

1. An explicit allowance for expenses
2. An explicit allowance for vested and expected future bonuses
3. Future premiums are valued at the actual office premiums expected.
4. Any differences in pricing and valuation are immediately taken as a profit or loss
5. Reserves may initially be negative for non-linked due to initial expenses
6. Reserves are sensitive to a change in basis

Question 3

What are some features of the net premium method?

Answer 3

1. It is simple
2. It makes no explicit allowant for future expenses
3. It makes no explicit allowance for future bonuses
4. For regular premium business, the reserves are relatively insensitive to changes in the valuation basis.

Question 4

What is a negative non-unit reserve?

Answer 4

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

Question 5

What are the constraints on negative non-unit reserves?

Answer 5

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

Question 6

How do we calculate negative non-unit reserves?

Answer 6

1. Project the expected future non-unit cashflows (income charges less outgo)
   2.Identify most distant cashflow
2. Set the reserve as an amount needed to meet the cashflow
3. Check that total reserve>surrender value
4. Move back to previous cashflow, discount reserve and subtract new cashflow for earlier time.
5. Carry on process working back to valuation date.