Revision questions - September 2018

[1495_sc]

Yes: this is referring only to the {present value of future shareholder profits} component of EV. We also need to add on the shareholders' share of net assets.

Be careful though: the present value of the release of the prudential margins in the reserves differs from the value of the release of the reserves themselves. Basically (ignoring tax):

PVFP (ie the present value of future shareholder profits)
= PV {Premiums + investment return - claims - expenses + release of reserves}
= PV {Release of prudential margins in reserves}

Ok. Will revise this topic to understand more about release of margins vs release of reserves. Thank you for guiding!

 

[Lindsay Smitherman]

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!

Ah yes - I see what you were saying now about the 'mistake', apologies.
And yes, the word 'surplus' can be confusing as it can be used to refer to both the excess of assets over liabilities and as a short-hand for what is actually 'surplus arising' (= the change in surplus) or, in other words, 'profit'.

 

[Lindsay Smitherman]

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.

Unfortunately I can't give you hard and fast rules about this - it will depend on the precise question wording.

However, FWIW I would be thinking about these sorts of practical or operational issues if the question asked me to discuss all of the factors that a company would consider when doing something (for a reasonable number of marks) or how it would go about deciding which approach to take out of various options, where each of these is a viable or acceptable way to achieve what it wants to do. But I would be less inclined to feel that going into detail on the operational issues were needed if the question is asking whether a particular actuarial / technical method is a suitable way of achieving a specified goal. Particularly where, as in this particular case, only one of the options is really actually viable, so whether or not it is going to take a bit of work operationally is basically irrelevant.

Although the question is 10 marks in total, bear in mind that you have got four different surplus distribution approaches to consider - which breaks it down into much smaller pieces, so there isn't a huge amount of depth needed on each.

 

[1495_sc]

Unfortunately I can't give you hard and fast rules about this - it will depend on the precise question wording.

However, FWIW I would be thinking about these sorts of practical or operational issues if the question asked me to discuss all of the factors that a company would consider when doing something (for a reasonable number of marks) or how it would go about deciding which approach to take out of various options, where each of these is a viable or acceptable way to achieve what it wants to do. But I would be less inclined to feel that going into detail on the operational issues were needed if the question is asking whether a particular actuarial / technical method is a suitable way of achieving a specified goal. Particularly where, as in this particular case, only one of the options is really actually viable, so whether or not it is going to take a bit of work operationally is basically irrelevant.

Although the question is 10 marks in total, bear in mind that you have got four different surplus distribution approaches to consider - which breaks it down into much smaller pieces, so there isn't a huge amount of depth needed on each.

Alright. Will keep this in mind. 10 marks for 4 types is reasonable, especially given that its not bookwork but application based and such questions would be more generous for marking. Thanks a lot!

 

[1495_sc]

Ah yes - I see what you were saying now about the 'mistake', apologies.
And yes, the word 'surplus' can be confusing as it can be used to refer to both the excess of assets over liabilities and as a short-hand for what is actually 'surplus arising' (= the change in surplus) or, in other words, 'profit'.

No problem! Yes. Made a note of this, especially for EV.

 

[1495_sc]

Yes: this is referring only to the {present value of future shareholder profits} component of EV. We also need to add on the shareholders' share of net assets.

Be careful though: the present value of the release of the prudential margins in the reserves differs from the value of the release of the reserves themselves. Basically (ignoring tax):

PVFP (ie the present value of future shareholder profits)
= PV {Premiums + investment return - claims - expenses + release of reserves}
= PV {Release of prudential margins in reserves}

I wanted to revise this topic before reverting but I still did not follow this logic/Core Reading. How is the release of margins in reserve same as PV {Premiums + investment return - claims - expenses + release of reserves}? Release of reserve is the reserve held vs actual payment to be made to policyholder when policy is settled whereas release of margins is effectively the difference between actual vs expected experience (mortality, expense, etc); PV of premium, investment return, claims and expenses are again actual figures. Can you please elaborate and help in understanding the difference between these concepts and how PVFP can be calculated as either of the equations above?

 

[Lindsay Smitherman]

Let's think about conventional business, for which reserve = PV{Claims + Expenses - Premiums} and PVFP = PV{Profits} = PV{Premiums - Claims - Expenses + Investment return + Release of reserves} = PV{Release of prudential margins in reserves}

Release of reserve over period = Reserve at start of period - Reserve at end of period
(ie 'Release of reserves' is the negative of 'Increase in reserves')

If reserves were calculated on a fully realistic (best estimate) basis, and what happened in the future was as per this basis, then the reserves (together with the investment return earned on them) would be exactly the right amount to meet the future claims and expense outgo, net of premiums received in. There would be no profit arising for shareholders from the monies backing those reserves (ie the shareholder would only receive the net assets). So: no prudent margins in reserves means no future profits expected to arise for shareholders.

Let's say instead that the reserves are prudent (ie have margins) and we are assuming in the EV projection basis a best estimate of what happens in future. Then, in the same way as above, as the reserves unwind over time they are used to pay out the claims and expenses (net of premium income), but the prudential margins within the reserves are not needed for this. Hence they drop into shareholder profit.

See the following for a more mathematical explanation, if preferred:

https://www.acted.co.uk/forums/index.php?threads/ev-and-pvif.15937/#post-61530