How does the sum at risk look like over the course of time for different types of policies? For example, whole life RP vs whole life SP vs unit linked vs endowment. Thank you!
Hi Kimiko The sum at risk for a conventional without-profits policy is the sum assured less the reserve. For both endowment assurances and whole life assurances, the reserve will grow over time as premiums are paid and interest is earned. So the sum at risk will fall over time. A single premium contract will have a bigger reserve and so will have a smaller sum at risk compared to a regular premium contract. The sum at risk for a unit-linked contract is the sum assured less the unit fund. Again the unit fund is expected to grow over time with premiums and investment return and so the sum at risk will fall over time. The unit fund may eventually overtake the sum assured so that the sum at risk is zero. Best wishes Mark
Hi Mark, Thanks for the above clarification. I however have a small confusion. My understanding is that Reserves are basically the sum kept aside by an insurance company for a contract to meet expected future outgo in excess of the expected future income. Therefore, reserves decrease over time as sufficient assets are build up (reducing the expected net outflow). This release of reserves also contributes to the profit expected from that block of business. The statement, "the reserve will grow over time as premiums are paid and interest is earned", does it actually relate to asset share? Thanks for your help in advance.
Hi Jaya Yes, you're correct to say that reserves are basically the sum kept aside by an insurance company for a contract to meet expected future outgo in excess of the expected future income. And yes, you're correct to say that the asset share for an endowment will grow over time as premiums are paid and interest is earned. However it's not correct to say that reserves decrease over time as sufficient assets are built up. When we calculate the reserves we need to allow for the full cost of the benefits and not just the cost in excess of the assets built up. A simple example might help. Consider a ten year pure endowment. We will ignore mortality, expenses and investment return for simplicity. The sum assured is 100 and the annual premium is 10. At time zero, after the first premium is paid the reserve is the value of the benefits (100) minus the value of the future premiums (9*10), so V0 = 10. So if we hold the reserve of 10 and receive future premiums of 90 we have enough to pay the claim of 100. At time one, after the second premium is paid the reserve is the value of the benefits (100) minus the value of the future premiums (8*10), so V0 = 20. So if we hold the reserve of 20 and receive future premiums of 80 we have enough to pay the claim of 100. At time two, after the third premium is paid the reserve is the value of the benefits (100) minus the value of the future premiums (7*10), so V0 = 30. So if we hold the reserve of 30 and receive future premiums of 70 we have enough to pay the claim of 100. So you can see that the reserves do increase over time as premiums are paid. It is these premiums that give the insurer the assets to back the increased reserves. I hope this helps. Best wishes Mark
Hi Mark, This was very helpful. I believe that the statement "The reserve will grow over time as premiums are paid and interest is earned" will be more intuitive if we consider it from a Retrospective reserve point of view. As premiums accrue over time which will eventually increase the reserve held for the policy. Is this correct?
Hi Rashi Yes it's true that the retrospective reserve for an endowment grows over time as premiums are added and interest is earned. It's also true that a prospective reserve for an endowment grows over time as each year we are deducting one year fewer of premiums and we are discounting for one year less of interest. Best wishes Mark
