EEV - MCEV - Solvency II EV

[gruhaa]

Yes, if the reserve held against the future GAO is calculated on a prudent basis, then the release of the prudential margins will be a positive part of the PVIF. However, bear in mind that the reserves are therefore higher than they need to be (by the amount of prudential margin) and so the 'net asset' part of EV will be lower accordingly.

A guaranteed annuity option is like a swaption (basically, an option on interest rates), because it comes into the money when interest rates change. The strike would be the interest rate at which the guaranteed minimum annuity rate was priced. See Chapter 15 Section 6.5 for further description of this idea. [Alternatively a GAO could be considered to be equivalent to a bond option, where the strike is the price which would generate the required minimum return supporting the guaranteed annuity rate.]

Thanks Lindsay. Your explanation is really helpful

 

[gruhaa]

Hi

It's the first of those.

In the MCEV Principles (copyright © Stichting CFO Forum Foundation 2008) this is stated as :
G1.5 A statement should be included to confirm that the methodology, assumptions and results
have been subject to external review, stating the basis of the external review and by whom it has
been performed.

Best wishes
Lynn

Hi Lynn
Can you please provide help answering the below questions, as i am really struggling on EEV chapterc
1.What does 'basis of external review' means?
2.Also, on points related the possibility of PVIF under SII,
a. Why would there be any difference between best estimate investment return and ViR used in calculating the BEL if MCEV is used, as investment return remains the risk free(plus LQP, if deemed appropriate) ? Are we assuming that company using non-market CEV where investment return are based on assets in which company has invested ?
b. The fourth bullet point says, release of risk margin, after allowing for cost of holding 'it'. My understanding was that we deduct cost of holding SCR, which broadly as same as risk margin under SII. Can you please elaborate this point in right Context?
3.If any company using non-market consistent EV under SII, then cost of capital shouldn't be the 'difference between investment return and shareholder required return(RDR) ' as given under principle 5. 'Frictional cost' should be used if market consistent EEV is used because there will be no difference between investment return and Rdr, so that cost would be tax and agency? Also do you agree of my reasoning about using frictional Cost under MCEV?

Thanks

 

[Lindsay Smitherman]

Hi Lynn
Can you please provide help answering the below questions, as i am really struggling on EEV chapterc
1.What does 'basis of external review' means?

That just means making clear what exactly the review is covering.

2.Also, on points related the possibility of PVIF under SII,
a. Why would there be any difference between best estimate investment return and ViR used in calculating the BEL if MCEV is used, as investment return remains the risk free(plus LQP, if deemed appropriate) ? Are we assuming that company using non-market CEV where investment return are based on assets in which company has invested ?

The discount rates used in the BEL will be based on risk-free rates, possibly including the addition of a matching or volatility adjustment (MA and VA). These are all effectively set by EIOPA. The best estimate investment return assumed in the EV projection basis will be the company's own estimates of risk-free rates + illiquidity premium. The latter, in particular, may differ from what EIOPA has set. Also, perhaps the company has not applied for (or been given permission for) an MA or VA, but believes that it should be able to take credit for an illiquidity premium. This would also lead to a difference.

b. The fourth bullet point says, release of risk margin, after allowing for cost of holding 'it'. My understanding was that we deduct cost of holding SCR, which broadly as same as risk margin under SII. Can you please elaborate this point in right Context?

See separate thread:
https://www.acted.co.uk/forums/index.php?threads/sii-eev-and-mcev.11868/

3.If any company using non-market consistent EV under SII, then cost of capital shouldn't be the 'difference between investment return and shareholder required return(RDR) ' as given under principle 5. 'Frictional cost' should be used if market consistent EEV is used because there will be no difference between investment return and Rdr, so that cost would be tax and agency?

This sounds correct, if you change 'shouldn't' to 'should' in the first sentence.

 

[gruhaa]

That just means making clear what exactly the review is covering.

The discount rates used in the BEL will be based on risk-free rates, possibly including the addition of a matching or volatility adjustment (MA and VA). These are all effectively set by EIOPA. The best estimate investment return assumed in the EV projection basis will be the company's own estimates of risk-free rates + illiquidity premium. The latter, in particular, may differ from what EIOPA has set. Also, perhaps the company has not applied for (or been given permission for) an MA or VA, but believes that it should be able to take credit for an illiquidity premium. This would also lead to a difference.

See separate thread:
https://www.acted.co.uk/forums/index.php?threads/sii-eev-and-mcev.11868/


This sounds correct, if you change 'shouldn't' to 'should' in the first sentence.

Hi Lindsay

In SII, do we deduct time value of option and guarantee along with intrinsic value.If not then shouldnt it a cause of PVIF under MCEV under SII?

 

[Lindsay Smitherman]

I am wondering if you are confusing the two very distinct concepts of calculating policyholder provisions and calculating shareholder value?

Apologies but I don't understand what you are getting at with your question 'In SII, do we deduct time value of option and guarantee along with intrinsic value.'

It doesn't make sense to deduct the time value of options and guarantees (TVOG) from technical provisions. The TVOG is part of the BEL. If there are options and guarantees in the products that are being valued, the BEL (being market-consistent) must be sufficient to cover both the intrinsic value and the time value of these options/guarantees.

Turning to your question about whether the TVOG is 'a cause of PVIF': the PVIF represents the value of future profits arising for shareholders. The TVOG represents the market-consistent best estimate of the amount that the company expects to have to pay out to policyholders due to these options and guarantees biting. It is not shareholder profit.

[Please be aware, as per the notice on the forum, that the tutors are very busy at the moment and so will not be able to keep answering these questions. Hopefully other students and forum visitors will be able to help out with further queries.]