Embedded Value

Hello,

I am bit confused on "Return on in-force business" item for determining the analysis of change in EV calculation.
(let's Define EV as= free assets + SCR & RM after deducting cost of holdings + PVIF , lets assume PVIF is being getting calculated by the company)

( as written in X4.2 solution)
So one of the item in analysis is "Return on in-force business". This part can be subdivided into-
a. Expected return
b. Non Economic experience variance
c. Non economic assumption variance (lets assume this to be zero)

a. Expected return- can be calculated by multiplying the rate of return with the opening VIF i.e. it unwinding discount rate.

b. Non Economic experience variance - can be calculated by:
- calculate the year end EV as it would have been if the expected non economic experience experience had happened
- This should equate to the opening EV + expected return on free surplus ( and expected return on required capital, less COH) and expected return on in-force business.
- Repeat the calculation but change one of items of experience from the expected value to its actual value.
- The change in EV at end of year gives the contribution from that item of experience.
- Repeat this process, changing each item one by one.

Now lets say, we have single premium protection product. We have been asked to divide the impact of "non economic experience variance" into all three component separately i.e., free assets + SCR & RM after deducting cost of holdings + PVIF .
I am wondering why the each component should get changed in "Non Economic experience variance" step under each of the following scenario?

Question 1: when Death observed are not equivalent to expected

b. Non Economic experience variance
Change in BEL: BEL will change due to change in in-force business (due to no. of deaths observed)
Change in Total Assets: Balance sheet Assets will change due to actual benefits outgoes.
Change in SCR: This will change due to change in underwriting risk component, as we have changed underlying BEL
Change in RM: Changed it is subset of of SCR.
Change in PVIF: Changed due to change in in-force business.

So, Change in Free Surplus = Total assets change - change in BEL - Change in SCR & RM (After COH)

Question 2: when no. of deaths are equal to expected (As assumed in PVIF calculation) case.
Here, the release of surplus cashflow from PVIF component will be equivalent to change in assets (in opposite direction). So no impact on EV due to this. But remaining components would still move and therefore, some amount be there under this header?

 

you mentioned this assuming S2 is followed and therefore profits are already realized at point of sale?

 

1. What is the difference between projection and superpisory basis in Embedded Value and where are they applied in the calculation?

2. How does PVIF compare with SII BEL? If PVIF is based on best-estimate assumptions, would it be the same as BEL? I read somewhere if best-estimate assumptions are used then PVIF is zero as PVIF is release of prudency in reserves and with best-estimate there is no prudency left. But I am not able to understand this logically. Example would useful.

Also, what is being said here in the course notes:
"Under Solvency II, the ‘required capital’ component of the EV calculation would include the
Solvency (or Minimum) Capital Requirement (SCR or MCR). It could also include the risk margin,
unless the release of the risk margin is instead allowed for in the PVIF – as mentioned in the final
bullet point above."

Is it saying that RC = SCR if release of margins is included in PVIF? and if not, then RC = SCR + risk margin?

 

Overall, not following how and why there is a difference in basis for Embedded Value calculations. Also, on what basis are the other components i.e. RC and FS determined? Projection or supervisory?

Also, is it right to say projection basis = best-estimate and supervisory = valuation which could be prudent or best-estimate?

 

Also, release of risk margin is different to release of reserves, is it? Former represents one period less of frictional costs of holding required capital and latter shows the change in required capital over the period?

[/QUOTE]

Yes, if the release of the risk margin is included as PVIF, then SCR = Required capital. However, if it is not, then it is part of the required capital.[/QUOTE]

 

Ok so I think I’m getting confused between the release of risk margin (or cost of holding required capital) and release of reserves itself, for EV calculations (under SII I believe this doesn’t make sense since everything is based on best estimate assumptions). Are these two different items or rather the same?