Asset share

[Abhilasha]

In calculation of asset share there are various deductions -
Expense
Cost of benefits
Cost of providing gtee
Cost of smoothing
Cost of return on capital
Shareholder transfer
Tax deduction

At say t=1, expense will be actual per policy expense incurred over last year and shareholder transfer would be for any declared RB or TB declared over past year, even taxes for past year.

But the cost of capital and cog or smoothing cost will be future projection right? These can't be retrospective?

 

[Em Francis]

In calculation of asset share there are various deductions -
Expense
Cost of benefits
Cost of providing gtee
Cost of smoothing
Cost of return on capital
Shareholder transfer
Tax deduction

At say t=1, expense will be actual per policy expense incurred over last year and shareholder transfer would be for any declared RB or TB declared over past year, even taxes for past year.

But the cost of capital and cog or smoothing cost will be future projection right? These can't be retrospective?

Hi Abhilasha

Depending on the size and the sophistication of the company, the CoG and CoS could be calculated prospectively; based on a stochastic model where, for example:
CoG:
= {The higher of the guaranteed benefit and the projected asset share} minus the projected asset share
CoS:
= Benefit paid (which is subject to smoothing) minus {the higher of the guaranteed benefit and the projected asset share}.

Or instead of the use of stochastic models, option pricing techniques could be used for the CoG, eg the valuation of a put option.

Regarding the cost of capital, the company may simply apply a % of capital used to support the wp fund or base it on the company's WACC and so could be retrospectively calculated.

Be mindful that there are many ways to calculate the asset share and for a small company a very broad brush approach may be adopted where no stochastic models are used.

Thanks
Em

 

[Abhilasha]

Hi Abhilasha

Depending on the size and the sophistication of the company, the CoG and CoS could be calculated prospectively; based on a stochastic model where, for example:
CoG:
= {The higher of the guaranteed benefit and the projected asset share} minus the projected asset share
CoS:
= Benefit paid (which is subject to smoothing) minus {the higher of the guaranteed benefit and the projected asset share}.

Or instead of the use of stochastic models, option pricing techniques could be used for the CoG, eg the valuation of a put option.

Regarding the cost of capital, the company may simply apply a % of capital used to support the wp fund or base it on the company's WACC and so could be retrospectively calculated.

Be mindful that there are many ways to calculate the asset share and for a small company a very broad brush approach may be adopted where no stochastic models are used.

Thanks
Em

Thanks Em.

 

[Lindsay Smitherman]

Just to clarify the points about the cost of guarantee and the cost of smoothing components: the insurer would not deduct the actual costs of guarantees and smoothing from asset shares as they are experienced. As explained in the course notes, this would be self-defeating.

The insurer instead would (if it chooses to do so) deduct a charge for the cost of guarantees, with the aim being that the accumulated charges over time would be sufficient to pay for the actual cost of guarantees when they bite. The charges could be based on the expected cost which, as noted above, could be determined using a stochastic projection or option pricing methods.

Similarly the insurer could deduct a charge for the cost of smoothing. Not all companies do this, since on average smoothing should be broadly neutral. However, as described in the course notes, if a company holds a smoothing account (a pool of supporting assets which allows smoothing to take place) then a charge might be deducted from asset shares to reflect the opportunity cost of tying this capital up for this purpose rather than using it to earn a higher return. So the charge could be based on the difference between the shareholders' required return on capital and the earned rate on those tied-up assets (or similar), applied to the smoothing account and deducted proportionately (say) between the asset shares.