Chapter 18

Hi everyone,

Hope you are all safe and happy!

I am struggling with ch18 of SP2. Could anyone please explain the example given on pg7 of this chapter? I am not getting the reasoning behind calculating company's profits using embedded value basis.
To be specific, my doubt is in calculating 'Expected future profit' i.e.
97.09×1.06 - 100 = 2.91

Please anyone help with this equation.
Thanks & Regards,
Bharti

 

Hi Bharti

I have tried to summarize what I understood from your question. So basically your doubt revolves around why life insurance would undertake an analysis of embedded value profit.

Insurance is a long-term business. This means one buy a policy today but continue to pay premiums for several years. It is from this future income that the insurers make profits. So the value of a life insurance company is assessed by future profits that the current business is able to generate. This is captured by the embedded value (EV) that represents the sum of the present value of all future profits from the existing business and shareholders’ net worth.

The highlighted part represents your shareholder's worth.

Hope I made sense there.

 

Hi Sachit,
Thanks for your revert.
I had doubt regarding why we have accumulated 97.09 using 6% in future profit and discounted 100 using 3% for supervisory reserve.

But I re-read the solution and now my understanding is that 3% is the rate we are using for reserving (to be prudent) and 6% is best estimate which we are using while calculating future profits, because in real, the rate earned is 6% but not 3%.
Is it correct?

 

Yes, right. The expected future experience is usually taken as best estimate (6% in this case).

 

Okay. Thank you so much Sanchit