Chapter 23 - Supervisory reserves and capital requirements (1) Flashcards
(20 cards)
What are the purposes of reserves
IS ALIVE
- to determine the liabilities to be shown in INTERNAL management accounts
- if SEPARATE accounts have to be prepared for the purpose of supervision of solvency, to determine the liabilities to be shown in those supervisory accounts
- to ASSIST with the assessment of reinsurance arrangements
- to determine the LIABILITIES to be shown in the insurer’s published accounts
- to influence the INVESTMENT strategy
- to VALUE the insurer for merger and acquisition
- to ESTIMATE the cost of claims incurred in recent periods and hence provide a base
for estimating the future premiums required to attain a given level of profitability
What are the uses of investigating the realistic / “true” position of the company
- To help demonstrate the long-term sustainability of profit distribution rates (such as bonuses) and hence to help determine current bonus declarations
- To help determine the realistic profitability of the company for the information of shareholders (etc) and management
- To assist in the general financial management of a life company
What are the two primary reserving methods
- Gross premium valuation
- Net premium valuation
Define Gross premium valuation method and what is its formula
This method is for placing a value on a life insurance company’s liabilities that explicitly values the future office premiums payable, expenses and claims, with the latter possibly including future discretionary benefits
Sum Assured + Renewal expenses - Office premiums
Define unit reserves
It is part of the reserve that a life insurance company needs to set up in respect of its unitised contracts. The unit reserve represents its liability in terms of the units held under the contracts
How would you calculate the unit reserve for a unit-linked policy
It is the number of units multiplied by their bid value
How would you calculate the non-unit reserve
It is the PV of the excess of non-unit outgo (eg expenses, benefits in excess of the unit fund) over non-unit income (eg charges, unallocated premiums).
What may regulations specify in terms of negative non-unit reserves held? (prudential valuation)
- The sum of the unit and non-unit reserve for a policy should not be less than any guaranteed surrender value
- The future profits arising on the policy with the negative non-unit reserve need to emerge in time repay the ‘loan’
- In aggregate, the sum of all non-unit reserves should not be negative
- After taking account of the future non-unit reserves, there are no future negative cashflows for the policy, ie there should be no future valuation strain
What are the salient features of the gross premium valuation method
PREBAS
P – Premiums valued are actual office premiums expected
R – Reserves may initially be negative for non-linked business (due to inital expenses, and partly due to capitalising the expected future profit)
E – Expenses are explicitly allowed for
B – Bonuses, both vested and expected future, can be explicitly allowed for
A – Allowance for profit/loss from pricing vs valuation basis differences
S – Sensitivity to changes in basis is high
How is the net premium valuation method calculated
It is calculated as the Present value of expected future benefit outgo less the Present value of future net premiums
The present values are calculated on the basis of interest and mortality only. There is no explicit allowance for expenses.
What are the features of the net premium valuation method
- It is simple
- It makes no explicit allowance for future bonuses
- It makes no explicit allowance for future expenses
- For regular premium business, the reserves are relatively insensitive to changes in the valuation basis (relative to gross premium method)
What are the reasons for valuing the assets and liabilities of a company
- To demonstrate solvency to the supervisory authorities
- To investigate the realistic / “the true” position of the company
How are non-unit reserves calculated (Prudential valuation)
- The calculation starts with the last projection period in which the net cashflow becomes negative
- An amount is set up at the start of that period which is sufficient, allowing for earned investment return over the period, to “Zeroise” the negative cashflow
- This amount is then deducted from the net cashflow at the end of the previous time period
- The process continues to work backwards towards the valuation date, with each negative being “Zeroised” in this way
- When the process is completed, if the adjusted cashflow at the valuation date is negative then a non-unit reserve is set up equal to the absolute value of that negative amount
What are the two methods of calculating non-unit reserves
- Prudential valuation
- Best estimate valuation (Market-consistent)
What is best estimate valuation for non-unit reserves
- The calcualtion would value all future non-unit cashflows, ie it would not disregard cashflows occuring after the last projection period in which there is a net outflow
- Negative non-unit reserves can be held
When does negative non-unit reserves occur
It will occur whenever the value of future positive cashflows outweighs the value of the negative cashflow
Why would a company want to hold negative non-unit reserves
They will reduce the total reserve under a contract (ie the sum of unit and non-unit reserves), and hence improve the capital efficiency of the product
What is the general algorithm for calculating non-unit reserves
- Project the expected future non-unit cashflow from the policy
- Identify the last cashflow
- Set the reserve as the amount needed to meet that cashflow at that point in time
( even if the cashflow is positive, set the non-unit reserve as a negative amount) - Check that the total reserve is greater than the surrender value
- Move back to the next previous cashflow, discount the reserve and then subtract from the reserve the new cashflow at the earlier time period. (repeat step 4)
- Carry on repeating the process working backwards over time to the valuation date
- This will give the required non-unit reserve
What does it mean for future profits of a company if a realistic valuation basis is used (ie the valuation basis is more lenient than the premium basis)
The company would ‘realise’ all the future profits that it would expect to make on account of the future premium being larger than it needed to be, according to this basis
Why is the net premium valuation method less sensitive to a basis change than the gross premium method
- The gross premiums are the future actual premiums payable
- The net premiums are assumed future premiums, to pay for the initial benefits only, calculated using the reserving basis assumptions for mortality and interest
So when reserving basis is changed, the NPV method changes by less because net premiums themselves are changed
