new business contribution in Analysis of change in EV

[qinfen]

In the solution for April 2015 exam, ASET, qn 2 part iv, there is a difference for this component under solvency I and II. Why is there such difference? what is the relavent rules/regulation under　ｓｏｌｖｅｎｃｙ　Ｉ and II which makes the difference in calculation?

 

[Em Francis]

In the solution for April 2015 exam, ASET, qn 2 part iv, there is a difference for this component under solvency I and II. Why is there such difference? what is the relevant rules/regulation under　ｓｏｌｖｅｎｃｙ　Ｉ and II which makes the difference in calculation?

The question is asking for the differences in the analysis of change in EV using the described approach given in the question compared to the standard approach.

The NB under the standard approach will be the impact from setting up the New business:
Free surplus contribution from NB (essentially premium - expenses - required capital - cost of holding required capital) + required capital + PVIF from this NB item.
Under the new approach. The contribution would also be the Free surplus contribution from NB (essentially premium - expenses - required capital - cost of holding required capital) + required capital. The main difference is the PVIF but as discussed in part i this shouldn't cause a big issue due to BEL containing best estimate assumptions.

Hope this helps.

Thanks
Em

 

[qinfen]

Thanks for your explanation.

 

[User 1234]

The question is asking for the differences in the analysis of change in EV using the described approach given in the question compared to the standard approach.

The NB under the standard approach will be the impact from setting up the New business:
Free surplus contribution from NB (essentially premium - expenses - required capital - cost of holding required capital) + required capital + PVIF from this NB item.
Under the new approach. The contribution would also be the Free surplus contribution from NB (essentially premium - expenses - required capital - cost of holding required capital) + required capital. The main difference is the PVIF but as discussed in part i this shouldn't cause a big issue due to BEL containing best estimate assumptions.

Hope this helps.

Thanks
Em

Hi EM, do we need to deduct the BEL (S2) / Reserves (S1) under the Free surplus contribution i.e. (essentially premium - expenses - BEL/Reserves - required capital - cost of holding required capital) ? Thanks

 

[VishalKumar]

Hi EM, do we need to deduct the BEL (S2) / Reserves (S1) under the Free surplus contribution i.e. (essentially premium - expenses - BEL/Reserves - required capital - cost of holding required capital) ? Thanks

One more query on the above equation that whether it should be change in BEL & change in Reqd capital ie BEL @t - BEL @t-1 and RC@t -RC@t-1
And how does the cost of reqd capital calculated, is it just the opportunity cost of holding this capital or ( increase in capital + BE interest earned on capital- the tax paid on this interest earned on capital).

 

[Lindsay Smitherman]

Hi EM, do we need to deduct the BEL (S2) / Reserves (S1) under the Free surplus contribution i.e. (essentially premium - expenses - BEL/Reserves - required capital - cost of holding required capital) ? Thanks

Yes - I agree with you.

For a non-Solvency II traditional EV the immediate NB impact on EV is the extra VIF plus the net asset impact, where the latter equals:
+ Initial premiums - Initial expenses - Reserves (and possibly also - Solvency capital requirements, depending on the definition of 'net assets', with these then being released in the VIF)

For a Solvency II EV performed under EEV/MCEV principles the immediate NB impact on EV is VIF, if relevant (this question is assuming it to be zero), plus (noting that the question implies that the company is defining 'required capital' as the sum of RM and SCR):

• the impact on free surplus = + Initial premiums - Initial expenses - BEL - RM - SCR
• the impact on {required capital - COHRC} = + RM + SCR - COHRC

For the immediate NB impact, the above BEL, RM, SCR would be as at time zero (ie the day the new policies are written). For the period end NB impact, they would be as at that valuation date, and we would also have investment earnings (from inception to the valuation date) included in the free surplus figure.

Hope that helps to clear that up.

 

[Lindsay Smitherman]

One more query on the above equation that whether it should be change in BEL & change in Reqd capital ie BEL @t - BEL @t-1 and RC@t -RC@t-1

We are considering here the new business contribution component of the change in EV, ie the contribution to the period end EV from new business written during the year. So the 'change in BEL' is simply the BEL for the new policies, since at the start of the period (time t-1 in your notation) these policies have not yet been written.

 

[Lindsay Smitherman]

And how does the cost of reqd capital calculated, is it just the opportunity cost of holding this capital or ( increase in capital + BE interest earned on capital- the tax paid on this interest earned on capital).

It is the opportunity (or 'frictional') cost of having this capital locked in.