X2 Series, 3 iv)

[1495_sc]

I did not understand the solution for 'SCR survival event'

SCR is defined as VaR measure of variation in basic own funds with 99.5% confidence over a year.
This means that SCR is such that there is only 0.5% chance than basic own funds will be below the SCR over a year, right?

How does this equate with "requirement to base SCR on a 99.5% one- year survival probability" as mentioned in the solution.

Please help.

 

[1495_sc]

2. i)
For impact on reserving, the solution mentions that reserving would not have a significant impact as "charges should be set to match taxation payment"

I did not follow this.
NUR is calculated as expenses + benefits in excess of unit reserve- charges

Now, charges will increase as tax relief is not available on expenses
How will charges relate to match tax payment and not affect NUR?

 

[Lindsay Smitherman]

I did not understand the solution for 'SCR survival event'

SCR is defined as VaR measure of variation in basic own funds with 99.5% confidence over a year.
This means that SCR is such that there is only 0.5% chance than basic own funds will be below the SCR over a year, right?

How does this equate with "requirement to base SCR on a 99.5% one- year survival probability" as mentioned in the solution.

Please help.

Be careful: the SCR is not set so that there is only a 0.5% chance that basic own funds will not cover the SCR. The SCR is about holding enough capital to meet the liabilities.

If a company only holds capital equal to its SCR, there is (in theory anyway) a 0.5% chance that it will be unable to meet its liabilities over a one-year period (ie it would be technically insolvent).

So the reference to 'survival' here is a simpler way of talking about the survival of the company (ie remaining solvent).

 

[Lindsay Smitherman]

2. i)
For impact on reserving, the solution mentions that reserving would not have a significant impact as "charges should be set to match taxation payment"

I did not follow this.
NUR is calculated as expenses + benefits in excess of unit reserve- charges

Now, charges will increase as tax relief is not available on expenses
How will charges relate to match tax payment and not affect NUR?

I think you mean Q1 here?

The NUR would also need to be sufficient to cover future tax expected to be due on the business (think of it as a type of 'cost' for the company). So if the amount of tax due on new business under the new regime is higher than the tax due on existing business under the old regime, the charges would simply be higher on the new tranche of business being written, and so it could just broadly cancel out. It's unlikely that the impact on the NUR will be zero, but the point being made in the solution is that there shouldn't be a significant impact on reserves.

 

[1495_sc]

Be careful: the SCR is not set so that there is only a 0.5% chance that basic own funds will not cover the SCR. The SCR is about holding enough capital to meet the liabilities.

If a company only holds capital equal to its SCR, there is (in theory anyway) a 0.5% chance that it will be unable to meet its liabilities over a one-year period (ie it would be technically insolvent).

So the reference to 'survival' here is a simpler way of talking about the survival of the company (ie remaining solvent).

How is SCR related to own funds then? Why is the definition of

I think you mean Q1 here?

The NUR would also need to be sufficient to cover future tax expected to be due on the business (think of it as a type of 'cost' for the company). So if the amount of tax due on new business under the new regime is higher than the tax due on existing business under the old regime, the charges would simply be higher on the new tranche of business being written, and so it could just broadly cancel out. It's unlikely that the impact on the NUR will be zero, but the point being made in the solution is that there shouldn't be a significant impact on reserves.

Are we saying that tax expense (included in NUR calculation) will cancel out due to increase in charges? I thought tax is not considered as an explicit expense item for calculating NUR.

 

[Lindsay Smitherman]

How is SCR related to own funds then? Why is the definition of

Own funds = assets minus 'liabilities'
SCR is the change in own funds under the overall 99.5% one-year VaR stress
If the company only holds an amount of capital equal to the SCR (plus of course the assets backing the liabilities) and the stress happens, it will (broadly speaking) JUST have enough assets to meet its liabilities

Say assets = 60 and liabilities = 60, and under the stress we have assets falling to 40 and liabilities stay at 60. We would then have SCR = 20 (since we have change in own funds from 0 to -20)

Holding 20 as the SCR (in safe assets that aren't impacted by the stress) means that under that same event the company would remain solvent, since assets would fall from 80 to 60 and liabilities would stay at 60. But anything worse happening than that 1-in-200 event, the company would be insolvent.

Having an excess of assets over the amount of liabilities within the calculation means that the impact of the stress event on the value of those assets is also taken into account.

You might be overthinking this. The question was about making the concepts clear to a Board member, so the solution was expressed in simplified terms. Can't feel that this is anything to get hung up on for the exam.

 

[Lindsay Smitherman]

Are we saying that tax expense (included in NUR calculation) will cancel out due to increase in charges? I thought tax is not considered as an explicit expense item for calculating NUR.

The non-unit reserve is the amount deemed to be sufficient to cover the excess of future expected cashflows out of the non-unit fund (which would have to include any tax payments that are not taken directly from the unit fund) over future charges expected to be received into the non-unit fund