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September 2015

1

1495_sc

Ton up Member
Hello-I need help with few miscellaneous doubts in this attempt.

Q1.

Part ii)

In the calculation of EEV, why are we including new business impact from immediate and deferred annuity? EV is the PV of cashflows from inforce business and shareholder owned net assets. It reflects impact of new business in a given year only when we compare EV of previous and current year. I did not understand why we need to make an explicit allowance for new business.

iii) If in the context of Solvency II, why is it difficult to establish a relation between reserving margin and profit margin in reinsurance premium? I understood the impact on net assets under Solvency I regime but wouldn’t the impact be similar for Solvency II ? The clear difference between the two regimes in this question will be that assets will increase in Solvency II due to reinsurance recoveries instead of treating the reinsurance recovery as a reduction from liability.

How is the overall impact on EEV= fee/profit charged by reinsurer?

iv)

Although the solution mentions that the change in investment return could be due to a change in investment strategy, why are we not establishing a direct relation between part iii and part iv? As the insurer enters into a reinsurance longevity contract, their investment strategy is bound to change due to this transaction. Hence justifying the change in investment return assumption.

For group deferred annuity comments, can we assume that death benefit is also payable and the withdrawal rate includes death (I thought of a one-off event like fire/earthquake as a reason for spike in withdrawal rate instead of other examples in the solution)? Why is there no reference of the assumption that deferred annuity withdrawals occur at the end of the year? Given this, it is likely that half year and full year withdrawal rate will be different and the insurer will have more visibility about the rate towards the end of the year.

Look forward to hear from anyone willing to comment! Thank you.
 
Hi

Please see my responses below.

1495_sc said:
Hello-I need help with few miscellaneous doubts in this attempt.

Q1.

Part ii)

In the calculation of EEV, why are we including new business impact from immediate and deferred annuity? EV is the PV of cashflows from inforce business and shareholder owned net assets. It reflects impact of new business in a given year only when we compare EV of previous and current year. I did not understand why we need to make an explicit allowance for new business.
Click to expand...
The analysis is looking at the change in EEV (measure of profit) so EEV at year end will include business written in the year and will now form part of the inforce business. The figures illustrated for 'End year' exclude these figures so you must add these into the end of year EEV before analysis.
1495_sc said:
iii) If in the context of Solvency II, why is it difficult to establish a relation between reserving margin and profit margin in reinsurance premium? I understood the impact on net assets under Solvency I regime but wouldn’t the impact be similar for Solvency II ? The clear difference between the two regimes in this question will be that assets will increase in Solvency II due to reinsurance recoveries instead of treating the reinsurance recovery as a reduction from liability.
Click to expand...
Because, under SII , the technical provisions are a fair value of the liabilities and include a best estimate plus an allowance for risk which may or may not be how the reinsurance premium is calculated.
So if assets increase by the BEL (adjusted for non recovery), then reduce by the reinsurance premium, it is likely to reduce free assets. However the free assets will increase by the reduction in the risk margin. It is therefore difficult to determine how the total free assets will move as it is not obvious whether the change in risk margin will be the same as the difference in the reinsurance premiums and the best estimate of reinsurance recoveries.
Whereas under SI, it is fairly clear that the prudent liabilities will be larger than the reinsurance premium.


1495_sc said:
How is the overall impact on EEV= fee/profit charged by reinsurer?
Click to expand...

The overall impact on EEV will depend on the total of the impact on the free assets, required capital plus PVIF. As investment return and discount rate are assumed to be equal, the required capital is included within the free surplus.
So:
EEV impact = Free asset impact + PVIF impact
Now let's say Insurance liabilities = Best estimate assumptions (B) + Prudent margins (P)
and Reinsurance premium = Best estimate assumptions (B) + Profit margin/Fee (F)
So Free asset impact = (B + P) - (B + F) = P - F
The PVIF has now reduced by the prudential margins (P) within the liabilities which the company no longer has to hold
So the overall EEV impact = P - F - P = F

1495_sc said:
iv)

Although the solution mentions that the change in investment return could be due to a change in investment strategy, why are we not establishing a direct relation between part iii and part iv? As the insurer enters into a reinsurance longevity contract, their investment strategy is bound to change due to this transaction. Hence justifying the change in investment return assumption.
Click to expand...
Entering into a longevity swap doesn't necessarily mean a change in investments. All the company is doing is swapping a fixed duration (based on estimate of life expectancy of annuitants) of payments for a variable duration of payments, which are dependent on actual profile of annuitants.

1495_sc said:
For group deferred annuity comments, can we assume that death benefit is also payable and the withdrawal rate includes death (I thought of a one-off event like fire/earthquake as a reason for spike in withdrawal rate instead of other examples in the solution)? Why is there no reference of the assumption that deferred annuity withdrawals occur at the end of the year? Given this, it is likely that half year and full year withdrawal rate will be different and the insurer will have more visibility about the rate towards the end of the year.
Click to expand...
I think this is not as common as the examples given and may be considered to be a payment of death as opposed to withdrawal.

1495_sc said:
Look forward to hear from anyone willing to comment! Thank you.
Click to expand...

Hope this helps.

Thanks
Em
 
Thank you! This was immensely helpful.

Only one follow up question related to part iv)- the question states that it is a longevity reinsurance transaction and not explicitly a swap. Would this not mean that the business is transferred (1000 million) in exchange of a premium? If the business is transferred, the assets required for meeting insurer's liabilities will be lower because of a reduction in liabilities after the transfer. Hence, this would require a change in the investment strategy. Can you help in understanding this? I did not interpret it as a swap in the first place because of the definition and terminology in the question.
 
1495_sc said:
Thank you! This was immensely helpful.

Only one follow up question related to part iv)- the question states that it is a longevity reinsurance transaction and not explicitly a swap. Would this not mean that the business is transferred (1000 million) in exchange of a premium? If the business is transferred, the assets required for meeting insurer's liabilities will be lower because of a reduction in liabilities after the transfer. Hence, this would require a change in the investment strategy. Can you help in understanding this? I did not interpret it as a swap in the first place because of the definition and terminology in the question.
Click to expand...
Hi
Sorry, yes you are right, it is not a swap.

There is still not expected to be an impact on this component as the component is the investment return earned on the assets backing the immediate annuities. This is referring to the immediate annuity liabilities which the company is still exposed to and hence will require matching fixed interest assets.
 
1495_sc said:
Still not able to understand. Can you please elaborate?
Click to expand...
All I am saying is that the company still has to reserve for these immediate annuities and the change in the expected rate will be based on the assets backing such. The fact that they may have lower reserves due to the longevity transaction shouldn't affect this.
 
Alright. So I am concluding that even if the requirement is now to hold lower volume of assets to back liabilities, this shouldn't affect the investment return as the nature of liabilities remains same. Hence, its the underlying assets only which matters.
 
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