2018 Sep Q1 (i)

[sfans19]

Looking at the examiner report for yield curve/risk free, what does the sentence below mean? How does it contribute to the increase in interest rate SCR?

‘For the unit linked business the impact on the charges will depend on their form (monetary or percentage of funds). If they are percentage of funds, then their value will be unchanged.’

I thought the unit linked fund is invested in equities and properties. Therefore, interest rate shock shouldn’t have any impact to it?

 

[sfans19]

Besides, under the Longevity heading, what does ‘the risk that the base assumption is too high’ mean?

 

[Em Francis]

Besides, under the Longevity heading, what does ‘the risk that the base assumption is too high’ mean?

Looking at the examiner report for yield curve/risk free, what does the sentence below mean? How does it contribute to the increase in interest rate SCR?

‘For the unit linked business the impact on the charges will depend on their form (monetary or percentage of funds). If they are percentage of funds, then their value will be unchanged.’

I thought the unit linked fund is invested in equities and properties. Therefore, interest rate shock shouldn’t have any impact to it?

With the monetary charge we would need to discount back this inflow into the non-unit fund at the higher risk free rate, reducing its value.

Whereas with the percentage charge of the unit fund we would be rolling up the unit-fund and discounting in the non-unit fund at the same risk-free interest rate so it cancels out. Remember, in a market-consistent (risk-neutral) valuation we assume everything grows at the risk-free rate, even though the actual investments are in equities and property.

 

[Em Francis]

Besides, under the Longevity heading, what does ‘the risk that the base assumption is too high’ mean?

This is referring to the mortality base assumption If this is higher than actual then the company is assuming people are going to die much sooner than the company are actually experiencing, and hence they will be paying out for longer than expected.

 

[sfans19]

With the monetary charge we would need to discount back this inflow into the non-unit fund at the higher risk free rate, reducing its value.

Whereas with the percentage charge of the unit fund we would be rolling up the unit-fund and discounting in the non-unit fund at the same risk-free interest rate so it cancels out. Remember, in a market-consistent (risk-neutral) valuation we assume everything grows at the risk-free rate, even though the actual investments are in equities and property.

Shouldn’t the BEL increase, rather than decrease as per the examiner report?

 

[sfans19]

This is referring to the mortality base assumption If this is higher than actual then the company is assuming people are going to die much sooner than the company are actually experiencing, and hence they will be paying out for longer than expected.

Can I use this point for other SCR eg persistency and expense?

 

[mugono]

Shouldn’t the BEL increase, rather than decrease as per the examiner report?

I haven't looked at the exam question / solution. Nevertheless, the BEL for unit-linked business will be equal to the unit fund + non-unit fund.

The BEL will reduce if the value of the non-unit fund is negative. This will occur when the PV of future charges exceeds expenses plus any benefits in excess of the value of the unit-fund, e.g. due to the existence of guarantees payable on death etc.

The BEL will increase if the value of the non-unit fund is positive.
Hope that helps.

 

[mugono]

I haven't looked at the exam question / solution. Nevertheless, the BEL for unit-linked business will be equal to the unit fund + non-unit fund.

The BEL will reduce if the value of the non-unit fund is negative. This will occur when the PV of future charges exceeds expenses plus any benefits in excess of the value of the unit-fund, e.g. due to the existence of guarantees payable on death etc.

The BEL will increase if the value of the non-unit fund is positive.
Hope that helps.

I should have added: a higher discount rate applied to a negative / positive NUR will increase / decrease this part of the unit-linked BEL.

 

[sfans19]

I haven't looked at the exam question / solution. Nevertheless, the BEL for unit-linked business will be equal to the unit fund + non-unit fund.

The BEL will reduce if the value of the non-unit fund is negative. This will occur when the PV of future charges exceeds expenses plus any benefits in excess of the value of the unit-fund, e.g. due to the existence of guarantees payable on death etc.

The BEL will increase if the value of the non-unit fund is positive.
Hope that helps.

My understanding is that BEL is PV expenses and benefits minus PV charges. Assuming that the non-unit fund is negative, say -10. When the interest rate increases, BEL will increase to, say -5, no?

 

[mugono]

My understanding is that BEL is PV expenses and benefits minus PV charges. Assuming that the non-unit fund is negative, say -10. When the interest rate increases, BEL will increase to, say -5, no?

BEL = UF + NUR.
Em's first response would appear to hold the key.

If the charges are applied as a monetary amount then the change in the VIF following an increase in rates looks to be ok (directionally). And the size of the (total) BEL will increase.

If the charges are applied as a % of the unit fund, changing the discount rate will not affect the PV 'charges' component of the NUR. The change in discount rate however will impact the PV expenses & benefits in excess of the unit fund components of the NUR. And the size of the (total) BEL will reduce.

 

[Lindsay Smitherman]

My understanding is that BEL is PV expenses and benefits minus PV charges. Assuming that the non-unit fund is negative, say -10. When the interest rate increases, BEL will increase to, say -5, no?

mugono is correct (thanks again!)

The non-unit part of the BEL is PV{expenses + benefits in excess of UF - charges}. [Close to what you have written, but be careful]

If we take the position that the charges are all expressed as a % of the unit fund (as is indicated in that part of the solution), PV {charges} is not impacted by a change in the interest rate.

So the interest rate increasing will reduce PV{expenses + benefits in excess of UF} and not change PV{charges}.

This leads to an overall reduction in the non-unit part of the BEL.

 

[sfans19]

mugono is correct (thanks again!)

The non-unit part of the BEL is PV{expenses + benefits in excess of UF - charges}. [Close to what you have written, but be careful]

If we take the position that the charges are all expressed as a % of the unit fund (as is indicated in that part of the solution), PV {charges} is not impacted by a change in the interest rate.

So the interest rate increasing will reduce PV{expenses + benefits in excess of UF} and not change PV{charges}.

This leads to an overall reduction in the non-unit part of the BEL.

Lower BEL shouldn’t contribute to the positive SCR, right?

 

[Em Francis]

it will have an impact on undiversified SCR and that is what you will get a mark for but yes it would likely decrease SCR.
However it could increase in some circumstances. For example, due to a fall in value of any fixed interest bonds within the surplus assets. Or/ And due the assets backing the non-unit reserve part of the BEL falling in value by more than the actual non-unit reserve.

 

[Himanshu Sikri]

Hi

Under the UL there are 2 components - Unit reserve + non unit reserve.
not unit reserve is clear from above discussion.
Assuming unit reserve are perfectly matched by the assets, in what scenario it will change, if any?

Thanks.

 

[Lindsay Smitherman]

The unit reserve part of the BEL will change whenever the value of the unit fund changes, eg through investment performance. There will, however, be an offsetting change in the value of assets backing the unit reserve.