Sept 2017 que 2 part (i)

[Rajat gupta]

Hi All,

I have a question on the solution to the above question. How can asset share become more negative (if initially negative), if we achieve "
Actual investment returns much higher than the best estimate rate
used in the previous projection."

Can somebody please explain on above?

Regards,
Rajat

 

[Mark Willder]

Hi All,

I have a question on the solution to the above question. How can asset share become more negative (if initially negative), if we achieve "
Actual investment returns much higher than the best estimate rate
used in the previous projection."

Can somebody please explain on above?

Regards,
Rajat

Hello Rajat

A negative asset share is just like having a negative bank balance. If the bank charges a high rate of interest then the debt grows at a faster rate, ie the bank balance becomes more negative.

Best wishes

Mark

 

[DamienW]

Hi Mark,
I have a question about the solution relating to lapse in (i).
The extent of the profit arising will depend upon the reserving basis used. [1]
If the product is reserved for on a prudent basis then more profit will be released on lapse, than if on a best estimate basis. [2]

I understand and agree with the narrative stated above, however,
1) This question is asked to compare the change of AS over one year between actual and BE basis. Why they discuss the profit? Is profit a component of AS? How can the lapse be reflected in the formula AS_t+1= (AS_t+P+Et)(1+i)-SA*n*qx?
2)- similarly, which component(s) of asset share are affected by assuming a prudent reserving basis vs a BE basis?

Many thanks

 

[Mark Willder]

Hi Damien

This is a tricky question. It all depends on whether we are calculating the asset share for the with-profits or the without-profits contract.

If the question were asking about the asset share of the without-profits contract then you would be right - the reserving basis would have no impact on the asset share. There is a mortality loss if the death benefit exceeds the asset share (not the reserve). Similarly we have a withdrawal profit as the lapse benefit (of zero) is less than the positive asset share at later durations (and withdrawal losses when asset shares are negative at early durations).

However, in this question paragraph four tells us that we are looking at the asset share of the with-profits contract. Paragraph three tells us that profits from without-profits contracts are added to the asset shares of with-profits contracts. Profits would usually be calculated with reference to the reserving basis as we cannot release funds backing the without-profits business unless their reserves are fully covered.

So your formula for asset share is correct if we are calculating a basic asset share. However, in practice we often make a range of adjustments to this for with-profits contracts, eg the course mentions deductions for cost of capital and shareholder transfers. Similarly we are adding the profits from the without-profits business here.

I hope this helps to explain the answer, but let me know if you have further questions.

Best wishes

Mark