Question 4 Sep11(part ii and iii)

[vikky]

Hi.
Part ii
Approach to valuing eev for a conventional with profits contract.I understand how we caculate future bonuses however am not sure how projected transfers would also include X%/(1-X%) of increase in reserves caused by bonus declaration.
Am also not sure what is frictional capital costs(part of the free surplus explanation)
related to this in part iii i cant see how that if regular bonuses are unchanged their projected (reserving) cost would rise causing higher shareholder transfers !!!!!
cost of bonuses are applied on sum assured and increase in prudence for reserving doesnt tamper with sum assureds for a contract..
dont know what am i missing here

AM REFERRING TO REVISION NOTE SOLUTIONS

 

[Lynn Birchall]

Hi

This is a tough question! There are more difficult issues in determining EV for with-profits than for without-profits contracts. SA2 gets into the WP side more, whereas ST2 generally avoids too much with-profit detail.

Approach to valuing eev for a conventional with profits contract.I understand how we caculate future bonuses however am not sure how projected transfers would also include X%/(1-X%) of increase in reserves caused by bonus declaration.

The X%/(1-X%) is doing the split between policyholders and shareholders. Imagine a fund is going to be split 90% p/h and 10% s/h. If we have a total of 100 to split, we declare bonuses worth 90 to give p/h their share. The shareholder transfer of 10 is then 10%/90% of 90.

I'll come back to the "increase in reserves part of this further down this post ...

Am also not sure what is frictional capital costs(part of the free surplus explanation)

Any frictional costs would be an attempt to recognise that the assets might be worth less to the shareholders because the insurance company has them (rather than the shareholders having the assets themselves). For example, there might me more constraints on the company, or it might be taxed more heavily. We certainly don't have to worry in this answer about how these costs might be determined.

related to this in part iii i cant see how that if regular bonuses are unchanged their projected (reserving) cost would rise causing higher shareholder transfers !!!!!
cost of bonuses are applied on sum assured and increase in prudence for reserving doesnt tamper with sum assureds for a contract..
dont know what am i missing here

You're right that a reversionary bonus is applied to the sum assured (plus bonuses to date). An issue arises in EV when we want to determine a s/h transfer related to this. The shareholder transfer should be "now", but the p/h doesn't actually get the bonus now. When we declare the bonus, the p/h benefit goes up, but the p/h will only get this in the future (when they die or reach maturity). To deal with this, the EV s/h transfers are often based on the value of the RB. This value is worked out using the reserving basis.

So, a more prudent reserving basis increases the transfers, even though the bonus rates don't change.

Lynn

 

[vikky]

Cheers Lynn