q 18.2 ii

[dimitris13]

hi
can someone explain ii 2 ?
especially the last 2 sentences. by distributing at the end dont we defer the most? how is this brought fwd and increase the EV?
i find these two last paragraphs (one says that EV idecreases) and the 2nd increases.
maybe an explanation with a trivial example?

thanks

 

[Lindsay Smitherman]

Hi - the situation in part (ii) of the question is that some of the free assets in the with-profits fund are instead being allocated to asset shares: let's say that this amount is A.

In the EV calculation that has A as part of the free assets, the solution considers two approaches by which A might be being valued:
Option 1: assumed to be releasable now, so the shareholders' share (eg 10%) will be valued at current market value, or
Option 2: assumed to be kept in the fund until the very end of the projection period

If instead A is part of asset shares, it will be released as terminal bonus and the corresponding shareholder transfer.

If the company is currently using Option 1 for its EV calculation, the release of A is now deferred (relative to what was being assumed) since terminal bonus will be paid out in the future, not all at the very start of the projection - so the EV might go down.

If the company is currently using Option 2, the release of A is now accelerated since terminal bonus will be paid out during the projection period not all at the end - so the EV might increase.

Does that make this clearer?

 

[dimitris13]

Hi - the situation in part (ii) of the question is that some of the free assets in the with-profits fund are instead being allocated to asset shares: let's say that this amount is A.

In the EV calculation that has A as part of the free assets, the solution considers two approaches by which A might be being valued:
Option 1: assumed to be releasable now, so the shareholders' share (eg 10%) will be valued at current market value, or
Option 2: assumed to be kept in the fund until the very end of the projection period

If instead A is part of asset shares, it will be released as terminal bonus and the corresponding shareholder transfer.

If the company is currently using Option 1 for its EV calculation, the release of A is now deferred (relative to what was being assumed) since terminal bonus will be paid out in the future, not all at the very start of the projection - so the EV might go down.

If the company is currently using Option 2, the release of A is now accelerated since terminal bonus will be paid out during the projection period not all at the end - so the EV might increase.

Does that make this clearer?

hi . many thanks on this. it is much clearer but at this stage of reading (1st one) i dont think i would produce such an answer (should i???).

 

[Lindsay Smitherman]

Don't worry - this is a fairly tough question. A lot of students find embedded value (particularly for with-profits business) one of the hardest parts of the course to grasp. Keep up the practice!

 

[yogesh167]

Hi - the situation in part (ii) of the question is that some of the free assets in the with-profits fund are instead being allocated to asset shares: let's say that this amount is A.

In the EV calculation that has A as part of the free assets, the solution considers two approaches by which A might be being valued:
Option 1: assumed to be releasable now, so the shareholders' share (eg 10%) will be valued at current market value, or
Option 2: assumed to be kept in the fund until the very end of the projection period

If instead A is part of asset shares, it will be released as terminal bonus and the corresponding shareholder transfer.

If the company is currently using Option 1 for its EV calculation, the release of A is now deferred (relative to what was being assumed) since terminal bonus will be paid out in the future, not all at the very start of the projection - so the EV might go down.

If the company is currently using Option 2, the release of A is now accelerated since terminal bonus will be paid out during the projection period not all at the end - so the EV might increase.

Does that make this clearer?

Please confirm my understanding below:
so lets suppose, asset share (AS) = 500 and free surplus (FS) = 100.

Option 1 - Releasable now...
Here, EV is equal to 10% of 100 (FS) plus PVST from future RB and TB to be declared from asset share of 500 in the future...(1)

if releasable now, and we allocate 30 of FS into AS then EV is equal to 10% of 70 (i.e.100-30) plus PVST from future RB and TB to be declared from 530...(2)
this is lower than calculated in (1)..

Option 2 - Allocated at end of period...
EV is equal to PVST from future RB to be declared from 500 (AS) and future TB to be declared from 100 (FS)...(3)

Here, if we allocate 30 of FS into AS at the end of period, then EV is equal to PVST from future RB from 530 plus PVST from 70 future TB...(4)
this is higher than calculated in (3)

Does this make sense or same as what you are saying?

 

[Lindsay Smitherman]

Not quite.
Yes for Option 1.
But for Option 2 I think we would have:

Before the allocation of the 30 we would have EV equal to PVST arising from whatever future RB and TB is expected to be declared from the 500 (AS) plus the additional PVST arising from giving the 100 (plus investment return on this amount) away at the end of the projection period (effectively as extra TB - it just hasn't been modelled to allow for a 'correct' run-off of claim timings)

After the allocation of the 30 we would have EV equal to PVST arising from whatever future RB and TB is expected to be declared from the 530 (new AS) plus the additional PVST arising from giving now just 70 (plus investment return) away at the end of the projection period

So because the shareholder transfer related to the 30 is expected to emerge faster under the 'after the allocation' scenario, the EV could be higher (assuming that discount rate > earned rate)