Sept 2015 Q3ii

[Matthew H]

Hi there,

Under the Financing heading (within the main answer section and the Additional points section) ASET says the following:

• "The change in surrender penalties may require an immediate increase in overall reserves given that surrender values have increased and reserves may need to be at least as large as those values."
• "The non unit reserves will increase if surrender penalties are explicitly allowed for."

Please could you help me understand these points. I don't understand the second one at all. As for the first one, the surrender value is never greater than 100% of the unit fund, and I thought that given we always hold the unit reserve then we wouldn't need to increase reserves? Or are we allowing for the fact that there's a surrender penalty and so the unit reserve being held is, on this occasion, less than the unit fund?

In my mind the main point about this change is the increased risk of withdrawals (ie there may be many more policies withdrawing with -ve assets shares than before), and so we're facing a potential loss. Except this point doesn't seem to be covered by the solution. So I'm wondering whether this is somehow wrapped up in the meaning of the first bullet?

Thanks,
Matt

 

[Mark Willder]

Hi there,

Under the Financing heading (within the main answer section and the Additional points section) ASET says the following:

• "The change in surrender penalties may require an immediate increase in overall reserves given that surrender values have increased and reserves may need to be at least as large as those values."
• "The non unit reserves will increase if surrender penalties are explicitly allowed for."

Please could you help me understand these points. I don't understand the second one at all. As for the first one, the surrender value is never greater than 100% of the unit fund, and I thought that given we always hold the unit reserve then we wouldn't need to increase reserves? Or are we allowing for the fact that there's a surrender penalty and so the unit reserve being held is, on this occasion, less than the unit fund?

In my mind the main point about this change is the increased risk of withdrawals (ie there may be many more policies withdrawing with -ve assets shares than before), and so we're facing a potential loss. Except this point doesn't seem to be covered by the solution. So I'm wondering whether this is somehow wrapped up in the meaning of the first bullet?

Thanks,
Matt

Hi Matt

The first bullet refers to the overall reserves, ie unit reserve plus non-unit reserve. While I agree that the surrender value is never larger than the unit reserve, we may have a situation where the non-unit reserve is negative. For example, unit reserve is 100, non-unit reserve is -4, so overall reserve is 96. In this case it matters if we change the surrender penalty from 5% to 0% at time 5 (as the surrender value was 95 and lower than the overall reserve but now becomes 100 and so larger than the overall reserve).

The non-unit reserve if the expected present value of the expenses (and costs of guarantees) less the charges. If we reduce the surrender charge then the non-unit reserve goes up.

It doesn't sound like negative asset shares are an issue here. The initial surrender value is 90% of the unit fund, which suggests the initial asset share is about 90% of the unit fund. If asset shares were negative then we'd expect a very much larger surrender penalty.

Best wishes

Mark