Revision questions - September 2018

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'.

 

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.

 

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