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Negative non unit reserve - Regulations

R

Rajat gupta

Ton up Member
Hi All,

Can somebody please explain the point 2 of When will negative non-unit reserves be held? " The future profits arising on the policy with the negative non unit- reserves need to emerge in time to repay the "loan". I am not getting what "in time" and "loan" refers to here and why does regulation placing restriction. Thanks in advance!

Regards,
Rajat
 
Rajat gupta said:
Hi All,

Can somebody please explain the point 2 of When will negative non-unit reserves be held? " The future profits arising on the policy with the negative non unit- reserves need to emerge in time to repay the "loan". I am not getting what "in time" and "loan" refers to here and why does regulation placing restriction. Thanks in advance!

Regards,
Rajat
Click to expand...
Hi Rajat

An example might help.

Consider an insurance company with two policies. The annuity policy has cashflows of -30, -30, -30, -30 and -30 and a positive reserve (assuming zero interest rates) of 150.

The unit-linked policy has non-unit cashflows of 40, 40 and 40 and a negative non-unit reserve of -120.

If the regulator is happy to allow negative non-unit reserves, then the overall reserve for the company is 150-120=30. Effectively the company is holding assets of 150 to cover the future annuity payments, but is holding assets of -120 for the unit-linked contract. So the unit-linked contract is actually in debt - it has borrowed 120 from the annuity contract, so that actually the company only has total assets of 30.

Now the company's assets of 30 are not enough to pay the annuity every year. But the unit-linked contract will repay it's debt from it's cashflows of 40 every year. In this case the loan in repaid in time because the unit-linked cashflows of 40 each year are more than enough to pay the annuity cashflows of -30. In year 1, the insurer has reserves of 30, they add the 40 from the unit-linked contract and pay the annuity of 30, leaving them with 40. In year 2, the insurer has reserves of 40, they add the 40 from the unit-linked contract and pay the annuity of 30, leaving them with 50. In year 3, the insurer has reserves of 50, they add the 40 from the unit-linked contract and pay the annuity of 30, leaving them with 60. The reserves of 60 are just enough to pay the annuity of 30 in the remaining two years.

Now consider a case where the loan is not repaid in time. The unit-linked contract generates cashflows of 20, 20 , 20, 20, 20, 20. The company would like to set up a negative non-unit reserve of -120, but it can't because the loan wouldn't be repaid in time. The annuity contract needs all it's money by year 5, but the unit-linked contract is still receiving cashflows in year 6. In this case, the regulation would limit the negative non-unit reserve to -100.

I hope this numerical example helped.

Best wishes

Mark
 
Hi Mark,

In the notes it mentions that regulation may not allow negative non unit reserves to offset unit reserves. Why would this be the case when we're allowed to use them to offset reserves for other products like in the example above?

Thanks,

Max
 
Hi Max

Regulation could restrict the offsetting of non-unit reserves against unit reserves because of a 'mismatch' issue, that the unit and non-unit components would change to different extents if future unit fund growth is better/worse than expected. This is problematic when it comes to the idea of needing to be confident that the future (non-unit) profits to emerge in time to repay the loan (from the unit reserves).

Hope this helps
Lynn
 
Hi Lynn,


Thanks for such a speedy response!


I'm struggling a little bit to understand how this would differ to if the negative non-unit reserves were offsetting some other non-linked reserves. If the unit fund growth was less than expected this would reduce the charges based on the value of the unit fund and so reduce the absolute size of the negative non-unit reserves. This would then restrict their ability to offset any positive reserves whether unit linked or not. So why is there then only a restriction on the negative non-unit reserves offsetting the unit reserves and not any other reserves?


Also, in the above example the non-unit cashflows are taken as certain whereas in real life they wouldn’t be. How would this impact the above example, would we have to multiply the expected cashflows by the probability of them occurring?


Thanks,


Max
 
Max Clinton said:
Hi Lynn,


Thanks for such a speedy response!


I'm struggling a little bit to understand how this would differ to if the negative non-unit reserves were offsetting some other non-linked reserves. If the unit fund growth was less than expected this would reduce the charges based on the value of the unit fund and so reduce the absolute size of the negative non-unit reserves. This would then restrict their ability to offset any positive reserves whether unit linked or not. So why is there then only a restriction on the negative non-unit reserves offsetting the unit reserves and not any other reserves?


Also, in the above example the non-unit cashflows are taken as certain whereas in real life they wouldn’t be. How would this impact the above example, would we have to multiply the expected cashflows by the probability of them occurring?


Thanks,


Max
Click to expand...

Good questions :)

1. In a SII context, the legislation / regulation doesn't prohibit insurers from being able to offest negative NUR with positive reserves held elsewhere.

The exception (life wouldn't be fun if there weren't any exceptions :)) would be for liabilities that are held within a matching adjustment portfolio (MAP). For such liabilities (and assets) there are prescribed eligibility criteria that would need to be satisfied. But even then, the MAP exists to ensure that insurers do not use the assets within the MAP to cover losses incurred elsewhere in the entity. Solvency II (unlike Solency I) does not 'force' insurers to zeroise (aggegate) negative reserves.

2. Insurers would probability adjust, e.g. for lapses or any othe relevant decrement, the non-unit cashflows when determining the non-unit reserves (similar to how they'd do it for other reserves).

This is quite a tricky area :).
 
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