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CM1-27 Practice Questions 27.2 (i)

Y

yuli2513

Very Active Member
Question is on page 37 and answers are given on page 43-45

I have two questions related to (i) of this question:
1. I got a bit confused of what interest is calculated/asked for here to fill out the table. In my opinion, the interest to be calculated should be the (reserve end of last year + premium income beginning of this year - expense this year) * 0.06

But the answer (last calculation on page 45 right before (ii)) ignores interest from reserves.I am wondering why the interest calculated as I described above is wrong here.

2. I am also wondering if the 4% interest rate given in the question is used anywhere in the answers.

Would really appreciate it if someone could help out here.
 
Hi,

We tend to separate out the calculation of interest on premium - expenses and the interest on reserves although you may be able to combine these together in other questions. In this question we are asked for the expected cost of increasing reserves. This is where we'll take the reserves at the start of the year, allow for the interest paid over the year and then see if we need any extra money at the end of the year to cover the expected reserve ie:

expected cost of increasing reserve = expected reserve at end of year - reserve at start of year x 1.06

The 4% interest on reserves does appear to be a red herring. If we had to calculate it from scratch we would calculate reserves ONLY using a discount rate of 4% and then go from there, but in this case we know what the profit vector is and so don't need to calculate the reserve from scratch...we can simply treat the reserve as a balancing item.

Joe
 
Joe Hook said:
Hi,

We tend to separate out the calculation of interest on premium - expenses and the interest on reserves although you may be able to combine these together in other questions. In this question we are asked for the expected cost of increasing reserves. This is where we'll take the reserves at the start of the year, allow for the interest paid over the year and then see if we need any extra money at the end of the year to cover the expected reserve ie:

expected cost of increasing reserve = expected reserve at end of year - reserve at start of year x 1.06

The 4% interest on reserves does appear to be a red herring. If we had to calculate it from scratch we would calculate reserves ONLY using a discount rate of 4% and then go from there, but in this case we know what the profit vector is and so don't need to calculate the reserve from scratch...we can simply treat the reserve as a balancing item.

Joe
Click to expand...
Hi Joe,

Thanks again for answering. I now understand it! :)
 
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