SP2 - IAI Dec 2020

Discussion in 'SP2' started by Bharti Singla, Jun 6, 2021.

  1. Bharti Singla

    Bharti Singla Senior Member

    Q.3) i) Describe the impact of decrease in the level of prudence in the reserves on the embedded value of unit-linked contract.
    Ans. i) For unit linked contracts, lower level of prudence in the reserving basis would decrease the requirement for non-unit reserves...

    The solutions talks about only the non-unit reserves, why not unit-reserves?
     
  2. Bharti Singla

    Bharti Singla Senior Member

    One more doubt in this paper:

    Q.4) Country Zari has a well-developed equity market. During the financial year end there was huge market volatility and many investors have lost 30% to 40% of values in a span of ten days. Insurance companies in the country also have a sizeable exposure to the equity market in their portfolio. Discuss the possible impact of market volatility on the insurance companies with regard to:
    i) Unit linked insurance products
    ii) With profit insurance products
    iii) Index linked insurance products
    iv) Without profit insurance products

    In part (ii) of the answer, there are two similar bullet points:
    g) It is possible that due to reduced bonuses, corresponding shareholders share of surplus distribution may also be reduced.
    h) Shareholders share of surplus may also be reduced in absolute level, in line with the declaration of reduced level of bonuses.

    I didn't get he difference between these two points. Could anyone please explain?
     
  3. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Hi Bharti

    The unit reserve will be the number of units multiplied by the unit price. There is no need to make any assumptions to do this.

    Best wishes

    Mark
     
  4. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    I agree that these sound very similar.
     
    Bharti Singla likes this.
  5. Sagar_sagar

    Sagar_sagar Active Member

    Hi Bharti

    As per my understanding, there is no unit reserve in unit linked contract, that's why solution talks about only non unit reserve.

    Also, non unit reserve/account comes into the picture if there are some sort of guarantees offered or if co. feels that it has worse actual experience than what have been considered in assumptions.
     
  6. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    I'm afraid that this isn't correct. Unit-linked contracts have a unit reserve and a non-unit reserve.

    But yes, the non-unit reserve may be needed if there is a guarantee. It might also be needed if charges do not perfectly match expenses and claim costs.

    Best wishes

    Mark
     
  7. Sagar_sagar

    Sagar_sagar Active Member

    Hi Mark
    Could you please confirm, what is Unit reserve ?
     
  8. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    For the purposes of SP2, the terms "unit reserve" and "unit fund" mean the same thing.

    The unit reserve for a unit-linked contract grows with the allocated premiums and falls with charges. Its value will go up and down with investment performance.

    The unit fund will be equal to the number of units multiplied by the unit price.

    Best wishes

    Mark
     
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  9. Bharti Singla

    Bharti Singla Senior Member

    So, I suppose it is the non-unit reserve which is most relevant in unit-linked contracts as there is a risk that the fund value may not be sufficient to pay the benefits if there is some guaranteed sum assured. So, the company have to keep enough non-unit reserves to meet the liabilities in case of poor investment performance. On the other hand, the investment risk is borne by the policyholders for the unit reserve, so the company doesn't require much reserve on unit side. Does that make sense?
     
  10. Sagar_sagar

    Sagar_sagar Active Member

    Hi Mark,

    Reserve is something which co. maintains to be able to pay for future uncertainty i.e. claims
    Unit account is completely own by policyholder and any risk arising out of it is also born by him.
    Co. doesn't have any role in respect to uncertainty on unit account

    Why you still refer unit account as a "unit reserve" ? Kindly elaborate
     
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  11. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Hi

    I disagree that reserves are there purely to deal with uncertainty. If the insurer knows that it must pay 100 with certainty, then it still needs to hold a reserve to pay the 100. The reserves are there to ensure that future cashflows can be met.

    So the insurer must hold a unit reserve equal to the unit fund as it knows that it needs to payout the unit fund on maturity (and often on death or surrender too).

    Best wishes

    Mark
     
  12. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    For the purposes of SP2, the unit reserve and unit fund are essentially the same.

    There are some exceptions to this. The insurer only needs to hold reserves to cover payments to policyholders, so any management box held on the insurer's behalf wouldn't be considered part of the reserve.

    You may also come across other adjustments to the unit reserve such as actuarial funding and unit shorting, but these concepts are beyond the current SP2 syllabus.

    Best wishes

    Mark
     
  13. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Hi Bharti

    I'm afraid I wouldn't agree with this. The unit reserve is really important and probably much larger than the non-unit reserve. I think your confusion lies in thinking about reserves as only dealing with uncertainty - see my other post in this thread to explain why this isn't true.

    A numerical example might help.

    Consider a unit-linked endowment assurance. The benefit at maturity or surrender is the return of the unit fund. The benefit on death is the larger of the unit fund and 200,000. The policy has been in force for some time and now has a unit fund of 140,000.

    The company needs to hold a unit reserve of 140,000.

    The company also needs to hold a non-unit reserve to cover any other costs not covered by the unit reserve. Let's assume that charges are reviewable and have been set to exactly cover expenses - so there is no need to have a non-unit reserve in respect of these cashflows.

    However, the unit fund isn't enough to cover the death benefit. The sum at risk is currently 200,000 - 140,000 = 60,000. Let's say that the insurer has a mortality charge that is designed to cover the cost of the death benefit. The mortality charge is reviewable so that it will be changed to exactly match the expected cost. So again we don't need a non-unit fund for future mortality costs.

    Let's say that the expected mortality is 1% and that the charge is deducted monthly. The probability of death is then one-twelfth of 1% and so the monthly charge is 60,000 x 0.01 /12 = 50. If the company has just received this charge then it needs to set up a non-unit reserve for the expected costs over the coming month - this will also be 50 as the charges are set to exactly cover the expected costs.

    So in conclusion, we can see that the company holds a very large unit reserve of 140,000, but a very small non-unit reserve of just 50. The non-unit reserve would be larger if charges did not cover expenses and mortality costs (perhaps because charges had been guaranteed), but the non-unit reserve would still be substantially smaller than the unit reserve. Maturity guarantees for unit-linked contracts are rare in the SP2 exam, but would lead to a bigger non-unit reserve.

    Best wishes

    Mark
     
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