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SA2 April 2015 (iv)

T

Tong_Tong

Active Member
Hello,

I just want to clarify my own understanding.

The question is asking how the approach would be different between using SI MCEV and SII MCEV?

Understand that in general the difference between SII EV and EV is that under EV, they may include the use the PVIF as the reserving basis is usually more prudent. However, for MCEV, I would have thought that SII MCEV is almost the same as SI MCEV. In this situation the SI reserves is effectively the SII BEL.

I am getting slightly confused regarding to the difference between the economic experience step:
Under MCEV SI, the projection basis is risk free rate + Liquidity premium, the reserving basis is risk free rate. Any difference between the actual investment return and rfr + liquidity prem will show up as PVIF. Under MCEV SII I thought this would the the same with the exception that any excess in actual investment return over rfr+ liquidity prem will captured with the increase in own fund. Why is the marking scheme telling me that under SII MCEV, economic experience impact is actual return vs rfr?

Thanks
 
Hi - you appear to be confusing the reserving (supervisory valuation) basis and the projection (experience) basis.

The reserving basis has to be whatever is appropriate for that particular jurisdiction. So if it is under SI the reserving basis would be prudent (since this is what was required under the old Solvency I regime); if it is under SII then it would be market-consistent.

The projection basis could either be a traditional EV basis (usually realistic / best estimate assumptions and a risk discount rate that includes a risk margin) or a market-consistent basis (with risk-free investment returns and risk-free discount rate). When reference is made to an 'MCEV' this means that the projection basis is market-consistent.

So a SI EV will always have a PVIF as there are prudential margins to release from the reserves, whether the projection is done on a traditional EV or MCEV basis.

Hence the following statements that you made above are incorrect: 'In this situation the SI reserves is effectively the SII BEL' and 'Under MCEV SI ... the reserving basis is risk free rate'. In both cases, 'SI reserves' must be the prudent reserves that are required under the Solvency I regime.

Hope that helps to clear that up.
 
Tong_Tong said:
I am getting slightly confused regarding to the difference between the economic experience step:
Under MCEV SI, the projection basis is risk free rate + Liquidity premium, the reserving basis is risk free rate. Any difference between the actual investment return and rfr + liquidity prem will show up as PVIF. Under MCEV SII I thought this would the the same with the exception that any excess in actual investment return over rfr+ liquidity prem will captured with the increase in own fund. Why is the marking scheme telling me that under SII MCEV, economic experience impact is actual return vs rfr?
Thanks
Click to expand...

Experience variation during the analysis period = difference between actual outcome and expected outcome over that period, where the expected outcome is as per the reserving (supervisory valuation) basis.
 
Lindsay Smitherman said:
Experience variation during the analysis period = difference between actual outcome and expected outcome over that period, where the expected outcome is as per the reserving (supervisory valuation) basis.
Click to expand...
Thanks,

I just want to clarify. Looking at the marking scheme it said "For the MCEV under Solvency I, the actual earned investment return would have been compared against the risk-free return plus any assumed illiquidity adjustment ... ". Does the RFR + liquidity adjustment refers to the discount rate used in reserving assumptions? I was under the impression that this is referring to Projection basis. So the experience variation is comparing projection vs actual rather than reserving basis vs actual.

Thanks,

Tong
 
Ah yes, thank you - I was getting too stuck in an 'analysis of surplus' thought process there (it was probably a bit too early in the morning for me!)

For an analysis of EV, the experience variation will reflect the difference between actual experience and what was expected under the projection basis assumptions.

[This is because the difference between the projection basis assumptions and the reserving basis assumptions will form the 'expected future profits' that comprise the PVIF component, and so we only get variation from that if actual outcome differs from what was expected in the projection basis.]

Sorry for any confusion
 
Thanks,

So is the marking scheme incorrect then when talking about the differences between SI MCEV and SII MCEV?

In this case the economic experience variance should be calculated in the same way under both approach since its the projection we are interested? So they both should be actual return vs "rfr +liquidity premium". Instead the marking scheme is saying that under SII MCEV is "rfr+MA" VS actual return.
 
Hi - this is a good question, but the MS is correct here. This is because, under the scenario for this particular question, it states that for the SII MCEV calculation the company has chosen not to hold any PVIF.

Hence the EV calculation is ignoring the difference between the (market-consistent) projection basis and the (Solvency II) reserving basis. In which case, this difference will also come through as experience variance each year. So (where there is no PVIF) the economic variance will reflect the difference between actual experience and what is expected under the reserving basis.

This is where my brain was at for my initial response. If a company does not include any PVIF in its EV calculation, then an analysis of change in embedded value is effectively the same as an analysis of surplus (ie of 'net assets'). So that's the situation we have here in this question, once the insurer switches to SII MCEV. But that wouldn't have been the case when it was doing an MCEV under SI.

Does that make more sense?
 
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