September 2020 Que3

Hi, could you please help me with this query in Que 3 (i) of sept 2020 exam paper:

*****************
The answer on page 9 on examination report talk about the asset share movement as follows:
* The asset share will be impacted depending on the investment strategy of the conventional with profit fund… [½]
• … but the movement in the asset share is likely to match the movement in the assets baking the asset share… [½]
• However, the matching may not be exact. [½]
• Any allowance for smoothing may impact the own funds, if it is assumed that the full impact of the shock would not feed through to smoothed asset share.

Que1 , why asset share is being mentioned here in calculating the net asset/own funds impact? is it because the ultimate payouts depend upon "max (gteed benefits, (smoothed)asset share )". Hence, while describing BEL, it is important to consider asset share movements as well?

Que 2: why the answer didn't talk about the impact of interest rate decreasing on own funds? Won't the decrease in interest rate will cause the decrease in risk free rate and hence increase in reserves?

Que 3: if above is true, I believe that the ultimate change in own funds will depend on the matching position...of how asset backing the reserves are matched to reserves. In with profit funds case, matching is though unlikely. but shouldn't this also needs to mentioned in answer?
******************
Que 4: Is cost of guarantee used in calculation on BEL for with profit contracts?

Que 5: How Cost of guarantee impacts/allowed in the estate/own funds? Is it that- the cost of guarantee increases the reserve, and therefore, automatically leads to reduced estate? How the deduction of cost of guarantee charge from asset share will impact the estate?

******************
In the same question (sept 2020 q3, page 10)
Que 6: "The impact on net asset value for the units of the unitised fund value should be zero, as the assets would be expected to be invested to match policyholder liabilities.".
In understand that in UWP, unitized funds is bid value value of units i.e. premiums less charges growing at rate of bonus. So these rate of bonus have relation which actual holding of assets, but they can vary also due to smoothing. Also, unit funds once increased can't be decreased even if the actual assets fall in value. It is likely that company can do mismatch in UWP also.
Then why, the examination report qouted so (which seems applicable more in unit linked funds rather than unitized )

Que 6: In the same question (sept 2020 q3) , the impact on SCR (Page 10) is mentioned in examiner's report. i am not sure why there is nothing mentioned about insurance risk module ? Could you please suggest the likely impact on different sub modules under this category?
******************

Que 7: page 13 of examiner's report say that " The company would need to consider the ability to alter the investment of assets backing asset share which would be determined by policyholder communication".
Assets backing the asset share are essentially the assets backing reserves?


Thanks and kind Regards.

 

Hi, same question, part i) Why fall in equity / property under stress leads to lower SCR? I thought required capital stress = Base avl capital - stress avl capital and the fall in equity / property would be part of the stressed avl capital calculation. I don'r understand why the answer says that the reduced assets values are base positions. Helpful with an example if possible.

 

Let's say equity is EUR300 , and to calculate SCR, stress of 40% reduction is applied.
So SCR from equity risk would be 300*0.4

Now if economic condition worsen and equity in balance sheet has reduced to eur200, the scr on this balance sheet equity will be
200*0.4

Thus the base has reduced from 300 to 200 and equity risk scr has also reduced

 

hi, thanks. I understand the change in base impact (300 to 200). Still not sure about the 40% stress. The 40% stress also reduces the equity price isn’t it (to 180), so why does it not have a similar impact?

 

Thanks.
And from a stress perspective, for equity scr, will the equity price be increased or decreased? Let’s assume under 2 scenarios, unit-linked product as well as a conventional product.

 

Hi, I understand the above responses and agree with them however I am finding it difficult to grasp that under a stressed economic environment the SCR requirement will be lower overall. Shouldn't the regulation mandate the company to hold more capital to ensure it is able to pay its liabilities?

 

Hi again, we don't consider the impact on BEL? Let's say the product being backed is a UL endownment plan. A fall in equity would also reduce the BEL, isn't it? In that case, the overall difference between asset and BEL would determine the stress magnitude, isn't it?

 

Still trying to grasp this logic. Let's say an endownment without profits is backed by equity (assuming the company is very large and has many free assets and regulator allows). Say, as at 31.12.2022 the BEL was 200 and Asset 300. Now as at 31.12.2023, the BEL is still 200 but assets fell to 200 (fall in equity prices). Now are we saying because the equity exposure is less (by 100), the insurer needs to hold less capital? This doesn't sound right somehow.

 

Very very helpful! You should be writing the core reading notes

Just a suggestion - examples like this in the course notes will be quite useful for students.