Revision questions - September 2018

Hello,

While revising the core reading, I came across few parts which I didn't understand completely. Can someone please help with a solution?

1. In contribution method of distribution of profits to with profit policyholders, why do we use the investment return to calculate expense surplus? For interest surplus, we are using the difference between valuation and actual interest rate for obvious reasons as the (res+prem) amount is invested but can't seem to apply a clear logic for expense surplus formula.

2. For retention of profit on surrender, how is the formula (EAS-SV')+ (SV'-SV'') derived? Why don’t we always consider the equation (EAS- SV) in all cases? This is a part of core reading of chapter 21, surrender values.

3. For analysis of embedded value profit, (chapter 3- Monitoring experience), last bullet for how it helps the company is as follows-

'provide detailed information for publication in the company’s accounts or those of any parent company, in particular the value of new business taken on by the company'

How is embedded value related to value of new business? By definition, it only calculates profit from existing business.

Thank you in advance!

 

Thank you, Mark! I have 2 follow up questions as follows-

1. The reason for rolling up expense for surplus calculation assuming they are incurred at the start of the year-is it because of the opportunity cost of accumulating the difference between valuation and actual expense somewhere else to generate return?

3. Can you please elaborate? In the financial statements of year ending 2020 , for example, the EV will only reflect shareholder owned net assets and future profits from existing business by definition. Are you suggesting that 'new business' here is the business written between 1st January- 31st December and if we compare this EV with that of 2019, we can understand the contribution of 'new business in 2020' to the EV?

 

Ok got it. Probably too much of variety with both SP2 and SP5 coming up!!

Thanks a lot!

 

Mark, can you also confirm if bid/offer spread is always applied to the offer price only (and not bid price)? I think so but the terminology 'bid/offer spread' can be misleading. There is context in Sept 2017's question paper, Q4 part iv).

 

Ok. In Sept 2017 Q4 part iv), there is a bid offer spread of 2% and although bid price is 98% of offer price, we don't account for this spread directly in the bid price. Instead, apply this spread to the offer price. In exam style questions, is this approach correct? If we always apply this spread to offer price only, it should take care of the bid price as well. Please confirm.

 

Ok. What I was really curious is to know 'where' to apply the bid offer spread in any question. Lets say we are calculating the offer price only-in this case should we simply deduct a 2% spread ? If we are only calculating bid price in a question which also mentions a 2% bid offer spread- is there any action point in this case?

I have few more miscellaneous questions based off Sept 2018's question paper. Can you please help?

Q5- How are premiums paid for unit linked annuity and charges? The solution comments about risks related to charges. The question mentions that its a unit linked annuity so shouldn't we assume that it is a single premium policy too? If single premium, will charges (if any), simply vary on the basis of movement of fund values and not any addition (like premium) to the fund value?

Q4-iii) If shareholders are entitled to 10% of the surplus in with profits fund, would it not imply that we should simply add 10% of the surplus to EV ? The solution mentions that we should add both 10% of surplus and future distributions of surplus. What is the fundamental logic behind this? Its a common mistake per Examiner's report also but I still didn't follow the logic.

Q3-iii) If after correction, the number of units allocated should be lower than current/redeemed units, how is this adjustment done? Especially for previous unit holders whose accounts have already been settled.
If there is a negative impact i.e units allocated should be higher than current units, it is reasonable to allocate additional units to existing policyholders and make cash payments to previous policyholders. Is there any real-life example of this situation that happened in UK or anywhere else?

Q2-We haven't talked about the administration system aspects of each bonus method. For example, how addition to benefits is most straightforward and simple while the company may not have credible information as its a new product for revalorization method. Is this because we are clearly in favor of accumulating with profits approach?

Q4. The embedded value for non-profit fund is the release of margins in statutory valuation basis compared relative to embedded value basis
However, we know that EV also consists of future profits from existing business which includes release of reserves and shareholder owned assets. Is the statement above a subset of what EV actually constitutes (only reflecting release of reserves)?

Thanks a lot for helping so far!!

 

Thank you! This was helpful.

 

Ok. Sounds good, thank you!

 

Was referring to this as a mistake by students.

Ok so we are just applying the traditional definition of EV here. Somehow the word 'surplus' made me think about PVFP only. Thank you!

 

Alright. Thank you for clarifying.

 

10 marks for this question made me think beyond technical aspects of each form of distribution. If we cover both technical aspects and operational issues related to these bonus types, will we get awarded for operational issues also? How can we distinguish when to talk about these issues and when not to?

Like I also thought of the cost element, consistency with existing bonus, administration requirements of each type. I understand your concern around being asked for factors vs suitability but in exam condition, making this distinction may not come naturally when high marks are allocated unless I know the caution keywords to look at before answering. Please advice.