SA2 April 21 Analysis of change in SII BEL

Hi

At SA level, a large proportion of the questions will not have answers that come directly from the course notes - they require adaptation of the underlying principles learned within the course to unfamiliar situations, and this question is a very good example of that. It requires blending of understanding of analysis of surplus with understanding of the calculation of the BEL.

An 'analysis of surplus' is an analysis of the change in surplus over the period. If we define surplus simplistically as 'assets minus BEL' then an analysis of surplus is basically an analysis of {change in assets minus change in BEL}. So an analysis of the change in BEL must have similarities to an analysis of surplus, hence we can use the Core Reading on analysis of surplus as our starting point. However, we need to ignore any components that relate to a change in assets. Actual expenses incurred during the period will impact the amount of assets held by the company.

Change in BEL = BEL at end minus BEL at start. Think about how the BEL is calculated (ie the present value of particular cashflows on a best estimate / market-consistent basis) and therefore how it changes over the year.

You will find more details on how to understand this solution in our April 2021 Mini-ASET product, which should be available soon (in eBook format): see https://www.acted.co.uk/paper_aset.html

 

Yes, that's broadly correct (it's a little more complicated than that, as set out in ASET, but you're along the right lines).

Re expense inflation:

Let's say that the start year BEL assumed that renewal expenses would be 10 per annum in the first projection year, inflating at 5% pa thereafter.
Then (assuming that everything has gone the way we expected it to during the year) we would expect the year end BEL to be assuming expenses of 10.5 per annum (= 10 x 1.05) in the new first projection year, inflating thereafter at 5%. [Think about the BEL calculation: when we move forward a year, the items in what was the first year have 'dropped out' of the calculation, and the items from what was the second year onwards would be the same but just now one year closer - assuming of course that everything has happened as it was expected to happen during the year.]

But if actual inflation during the year was 3% rather than 5%, the year end BEL would likely be assuming expenses of 10.3 per annum in the first projection year, inflating thereafter at 5% (assuming no changes to the future inflation assumption).

Hence we have a difference between the actual year end BEL and the expected year end BEL due to the actual inflation during the year differing from what we expected it to be.

As we explain in ASET, experience variances that only impact cashflows arising during the analysis period (such as expense over-runs that are not expected to continue in the future) would not be relevant to the analysis of change in BEL. But experience variances that do impact the future cashflows valued in the BEL would be relevant.

Hope that helps.

 

That list of components is a great starting point, but of course you need to filter carefully to make sure that you are only covering those that impact the BEL, so some would need to be adapted accordingly and some would not be relevant.

 

Expenses being higher than expected would mean the assets at the year end are lower than they would otherwise have been (spent more money than expected) but this doesn't directly impact the BEL - so is not relevant here.

The only way in which the BEL would be impacted would be if the insurer decided that its view of future expenses has now changed as a result of the over-run. But that would be an assumption change, not an experience variance.

 

Yes, correct