With-profits technical provisions

[Lindsay Smitherman]

2.the cost ot guarantee calculated above is intrinsic value of guarantee or time value of guarantee ? i believe it is intrinsic value because is the best estimate(average) . if you agree, then should time value be somewhat greater than average value, say 75th percentile of the cost distribution ?

No - it is the sum of both intrinsic value and time value. Using a stochastic model means that the time value (the probability of the guarantee biting under different scenarios) is allowed for. The total cost of guarantee for a particular policy is the simulated cost of guarantee divided by the number of simulations.

 

[Lindsay Smitherman]

2. given the valuation is under SII, should the asset share in stochastic model be projected under risk free rate(as it is the assumed investment return under sii) ?

The economic scenarios used in the stochastic model should be calibrated so that the expected return for each asset type is the risk-free rate. The simulated returns under each scenario will then vary around that expected rate according to the volatilities allowed for in the ESG.

 

[gruhaa]

No - it is the sum of both intrinsic value and time value. Using a stochastic model means that the time value (the probability of the guarantee biting under different scenarios) is allowed for. The total cost of guarantee for a particular policy is the simulated cost of guarantee divided by the number of simulations.

so doing the calculations under one scenario would just give me instrinsic value. but simulations take care of both intrinsic value and time value ?

 

[gruhaa]

The economic scenarios used in the stochastic model should be calibrated so that the expected return for each asset type is the risk-free rate. The simulated returns under each scenario will then vary around that expected rate according to the volatilities allowed for in the ESG.

i am sorry but i couldn't understand the above. can you please help me with an numerical example on what calibration we perform and upto risk risk rater? and are we talking about volatility around calibrated risk free rate ?

 

[Lindsay Smitherman]

i am sorry but i couldn't understand the above. can you please help me with an numerical example on what calibration we perform and upto risk risk rater? and are we talking about volatility around calibrated risk free rate ?

Let's say that we are calibrating the economic scenarios for equities. Let's say that we think that the standard deviation (or volatility) of annual equity returns is 5% and that the risk-free rate is 2% pa. Then the 10,000 (or however many) equity investment returns that are simulated within the ESG will have an average (expected) return of 2% pa and the standard deviation of equity investment returns within those 10,000 simulations will be 5% (over each one year period).

 

[TWY]

Hi - yes, your second point is correct (not your first one).

The guarantees provided by the basic sum assured and regular bonuses which have been declared up to the valuation date may "bite" at the claim date, and this forms part of the (market consistent) "cost of guarantees" element of the BEL.

And then future regular bonus becomes guaranteed once declared, and this also has to be allowed for in the BEL - so further increases the "cost of guarantees" within the BEL.

Hope that helps.

Hi, what if as we declare the bonuses we switch the asset holding to cash and bonds? So at any valuation date, the assets backing the guarantees provided by the basic sum assured and regular bonuses which have been declared to date are being backed explicitly by bonds and cash? In such a case there isn't a chance that these guarantees can 'bite'? Therefore the "cost of guarantees" would only be contributed by future regular bonus declarations?

Or will this not really happen in practice as it'll reduce the potential to meet future bonus expectations?

 

[abcdeqwer]

Hello, this is an incredibly helpful thread - thanks for all the insights! I just have one nagging question that may be implicitly covered in the replies, but couldn't seem to figure out myself:

I understand that we need to project forward the asset shares to calculate the cost of guarantees. However, I'm curious about what the SII BEL for a WP contract is as at the valuation date (e.g. today). Is BEL = smoothed AS as at valuation date + cost of guarantees, or do we also project forward the (smoothed) AS and COG (and expenses, premiums) to the maturity date then discount back to the valuation date? Or are both of these somehow equivalent or acceptable approaches taken by companies in practice?

Thanks a lot, and hope my question was clear enough!

 

[abcdeqwer]

Thanks a lot for the quick reply Mark.

So could I just confirm if my understanding is correct: for a particular valuation date, the SII WP BEL = (smoothed) AS + cost of guarantees, where

• Smoothed AS is as at the valuation date today (i.e. just a retrospective asset share)
• Cost of guarantees would be calculated taking into account the current and (projected) future bonuses, then comparing this projected guaranteed amount with projected (smoothed) AS at the maturity date, then discounting back to valuation date

Also, just wanted to clarify that the part you mentioned about only considering current guarantees would be referring to the smoothed AS portion?

However, we'd only consider the current guarantees, ie we wouldn't add on the bonuses we might expect to declare in the future. Once we have the cost of the guarantees at maturity, we then need to take their average value from the simulations and discount them back to get the cost to include in the BEL.

Thanks so much, and please let me know if I did not interpret your reply correctly!

 

[Mark Willder]

Thanks a lot for the quick reply Mark.

So could I just confirm if my understanding is correct: for a particular valuation date, the SII WP BEL = (smoothed) AS + cost of guarantees, where

• Smoothed AS is as at the valuation date today (i.e. just a retrospective asset share)
• Cost of guarantees would be calculated taking into account the current and (projected) future bonuses, then comparing this projected guaranteed amount with projected (smoothed) AS at the maturity date, then discounting back to valuation date

Also, just wanted to clarify that the part you mentioned about only considering current guarantees would be referring to the smoothed AS portion?


Thanks so much, and please let me know if I did not interpret your reply correctly!

Hello

Thanks for checking back for clarification.

Yes, everything you've written here is correct.

Sorry, you're right to query my comment about future bonuses. I made a mistake here. So yes you should project the bonuses that you expect to declare in the future under each simulation when calculating the cost of guarantees.

Best wishes

Mark

 

[abcdeqwer]

Got it, thanks a lot for your help Mark!