April 2022 Q6 (i)

The suggested answers in the examiner report mentions:


1) [A low lapse assumption will be more prudent if reserves are positive, as will be the case later in the term but a high lapse assumption could be more prudent if reserves are negative early in the term..]

2) [We would expect the actual expenses to be higher than the assumptions if the basis was prudent..]
[We would expect the actual investment returns to be lower than the assumptions if the basis was prudent..]


Q1) How is a low lapse assumption more prudent with positive reserves? I would think regardless of the level of reserves set, it is always more prudent to assume higher than expected lapses when setting up supervisory reserves, in the context of a portfolio of term assurance policies.

Q2) If the basis was prudent, we would expect to assume higher expenses and lower investment returns in our supervisory reserve calculations. So wouldn't it be correct to say that the actual expenses and actual investment returns will be lower than what was assume in our prudent assumption settings?

 

Just a minor amendment to my question 2 to make it clearer, I meant to ask the following:

If the basis was prudent, we would expect to assume higher expenses and lower investment returns in our supervisory reserve calculations. So wouldn't it be correct to say that we expect actual expenses to be lower and actual investment returns to be higher than what was set up in our prudent assumption basis?

 

Hi there,

I will try answering this question if I may and the tutors can correct me if I am wrong.
1) A low lapse assumption is more prudent when reserves are positive in the later term of the policy.

There are three points here which we have to keep in mind.

• As we are considering term assurance we have to keep in mind that there are no surrender values available.
• Also another key point mentioned here is that the lapse is later in the term of the policy rather than early duration.
• The reserves are positive

As the lapse is later in the term, the asset share would be positive as compared to early durations where more withdrawals would be a loss since asset share is negative. It doesn't matter how the withdrawal benefit compares with the asset share when asset share is negative(which means it will always be a loss with negative AS).
Therefore when it is later in the term of the policy more lapses means we no longer need to hold the positive reserves for them anymore and there will be a release of reserves which will lead to increased profits. But if we consider less lapses then we need to hold reserves for them which increases our liabilities and hence more prudence.
In case of negative reserves the situation will be reverse.

 

I am not quite sure of the second point because what you are saying seems correct. We would assume more expenses and low investment returns in case of prudent reserves. Which means the actual experience should be better than that leading to lower actual expenses and higher actual investment returns.

 

Hi

1.Even I didn't understand in what context does the examiner's report say that,"
[We would expect the actual expenses to be higher than the assumptions if the basis was prudent..]
[We would expect the actual investment returns to be lower than the assumptions if the basis was prudent..]".

As per my understanding, we would expect lower actual expenses and higher actual investment returns.Could u pls explain?

2.Please explain what are the valuation assumptions in this question. I can only see the 1 year and 5 year actual experience data.

Thanks!

 

I agree the examiners report looks wrong to me, ACTED may have corrected this in miniASET solutions for this paper.

The question does not give the experience data, the figures are just a relative comparison between actual experience and the reserving assumptions, eg 1 year mortality = 120% means there were 20% more deaths relative to what was assumed in the reserving basis, in the past year.