Hi, The answer to the question(Sept 2005, Qn 3, Part ii) says ' Under the net premium valuation method, future premium valued vary with the valuation rate of interest'. Why is that? At another part in the examiners report, it is mentioned 'Gross premium reserves are more sensitive to changes in market conditions'. Why is it so? How does net premium and gross premium method work and how are they different from each other?(I know this is a very basic question , but most of my confusion seems to arise from not understanding the difference between the two clearly.)
Gross and Net Premium Reserves This is the main area where I think it's worth going back and re-studying the ST2 Course Notes, which cover these reserving methods quite thoroughly. This is all "assumed knowledge" for SA2, so it's a good idea to make sure your clear on these methods. Your questions are all related, so can be answered together. The gross premium reserve is the present value of all future cashflows, ie benefits, expenses and premiums. Whenever the basis is changed, the value of all these components will change. The net premium reserve is quite artificial and is defined to be the present value of the benefits less the present value of the net premiums, which are defined to be those premiums necessary to cover the initially-guaranteed benefits using the reserving basis. So every time the basis changes, the net premium is re-calculated and causes a change in value that partially offsets the change in benefits. This feature results in a method that is relatively insensitive to basis changes for regular premium business. Another advantage of this method (from the regulator's perspective) is that it doesn't capitalise future profits since it doesn't take credit for the profit loadings in future premiums.
