Unit pricing (16) Flashcards
Recap
Unit-linked products
- unit-linked benefit is determined by the performancce of units, whcih itself is determined by the performance of the underlying assets
- used for savings and protection
- cost of protection element is met by explicit charges
- expenses are met by a variety of explicit chargers, which are normally variable
- very capital efficient for the company
Simple way of calculating
Unit price
Value of the underlying fund of assets / number of units
What is an
Internal unit-linked fund
- consists of a clearly identifiable set of assets
- e.g. equities, properties, fixed interest securities and deposits
- fund is divided into a number of equal units cosisting of identical sub-sets of the fund’s assets and liabilities
- responsibility for unit-pricing rests with the company, subject to relevant policy conditions
what is
management “box”
- companies create more units in their fund than is strictly necessary to cover the corresponding unit liabilities
- used to manage the flow of policyholders buying an selling units
- will reduce the need to cancel and create units each day
Risks of maintaining a management “box”
- risk that assets will decrease in value
- operational risk to keep track which units belong to the company and which belongs to the p/h
- risk that expenses for running the box are higher than expected
The basic equity principle of unit pricing
The interest of unit-holders not involved in a unit transaction should be unaffected by that transaction
- strictly, a company only needs to determine unit prices when a transaction takes place
- however, more frequent valuation are done to inform p/h on the value of their funds and the performance
- In theory, the movement in price between those two events should only reflect the performance of the assets backing the unit and charges deductible under the policy terms.
- Therefore the price of units should not be affected by creation or cancellation of other units, otherwise cross subsidies between unit holders will arise.
definition
Appropriation price
- amount of money put into the fund for each unit created such that the NAV per unit is the same after as before the appropriation
- price at which the company will create a unit
- the amount of many that the company should put into the fund n respect of each unit creates inorder to present the interest fo the exisiting unit holders
- the best price at the underlying assets can be purchased, taking account of relevant dealing expenses
Expropriation price
- the amount of money taken out of the fund in respect of each unit cancelled so that the net asset value of the remaining units remain unchanged
- the price at which the company cancels units
- the amount of money taken out of the fund in respect of each unit cancelled in order to preserve the interest of continuing unit-holders
- the best price at which the underlying assets can be sold, taking into account dealing expenses
Calculation process
Appropriation price
Market (offer price) value of the assets held by the fund + expenses that would be incurred in the purchase
+
value of current assets (cash on deposit or investments sold but not settled)
-
value of current liabilities (investments purchased but not settled or loans)
+
accrued income (interest income from fixed-interest securities and deposits)
-
allowance for accrued tax
=
Net asset value of the fund on an “offer basis”
NAV of offer basis / number of units = appropriation price
Calculation process
Expropriation price
Market (bid price) value of the assets held by the fund + expenses that would be incurred in the sale
+
value of current assets (cash on deposit or investments sold but not settled)
-
value of current liabilities (investments purchased but not settled or loans)
+
accrued income (interest income from fixed-interest securities and deposits)
-
allowance for accrued tax
=
Net asset value of the fund on an “Bid basis”
NAV of bid basis / number of units = expropriation price
Offer basis
- marginal transation involves the creation of units
- required fund to be valued on an offer basis
- with the amount of money put into the fund being equal to the net number of units being created x appropriation price
NET number: requested unit purchases can be paired off with unit sales
only have to create (or cancel) units equal to the net result of all purchases less all sales
Bid basis
- marginal transaction involves the cancellation of units
- fund is valued on a bid bases
- the amount of money taken out of the fund equals the net number of units cancelled x expropriation price
Offer and bid prices when pricing on an offer basis
Offer price: price at which units are offered for sale to the policyholders
Bid price: price at which units are bought from policyholders
Situation:
* unit prices determined daily
* number of unit allocated > number of units surrendered
* requires a net creation of units
* pricing is done on offer basis
* bid and offer prices are derived from appropriation price
* adjustments are made:
- initial charges
to meet management expenses
offer price = appropriation price + initial charge(bid-offer spread) - rounding
offer price rounded up
bid price rounded down
to favour the company
Offer and bid prices on a bid basis
Offer price: price at which units are offered for sale to the policyholders
Bid price: price at which units are bought from policyholders
Situation:
* unit prices determined daily
* number of unit surrendered > number of units allocated
* requires a net cancellation of units
* pricing is done on bid basis
* bid and offer prices are derived from expropriation price
* adjustments are made:
- initial charges
to meet management expenses
offer price = appropriation price + initial charge(bid-offer spread) - rounding
offer price rounded up
bid price rounded down
to favour the company
