actuarial funding and non-unit reserves

Discussion in 'SP2' started by bensondros, Aug 26, 2012.

  1. bensondros

    bensondros Member

    Hi,

    Are the use of actuarial funding and negative non-unit reserves concurrently allowed? Or do companies have to choose one of the two methods to reduce valuation strain on unit-linked policies? If they have to, which one do they normally go for, and why?

    Thanks.
     
    Last edited by a moderator: Aug 26, 2012
    bensondros, Aug 26, 2012
    #1
  2. mugono

    mugono Ton up Member

    Whether actuarial funding or negative non-unit reserves is adopted will be driven primarily by the insurer's contract design. Whether it's 'allowed' will depend on whether the necessary requirements are fulfilled.

    For one, actuarial funding can only be used on unit-linked business, so any non-unit linked contract design cannot use actuarial funding.

    Similarly, were the insurer to have a premium related surrender penalty on unit-linked contracts they wouldn't be able to use actuarial funding as it would be difficult to ensure that they would have enough to meet the p/hs surrender benefit.

    As the alleviation of NBS will be the objective, the method that best achieved this, considering the contract design would likely be a key criteria.
     
    mugono, Aug 26, 2012
    #2
  3. bensondros

    bensondros Member

    Assume that all conditions for actuarial funding and negative non-unit reserve are satisfied. Ie, it is a unit-linked endowment assurance, and the surrender penalties are designed in such a way that a negative non-unit reserve can be held at the valuation date. Is the company then allowed to use both? <-- did a search on the forum, it seems it's possible depending on the surrender penalties.. (http://www.acted.co.uk/forums/showthread.php?t=4582)

    Just a thought..is this never possible in the real world because after using actuarial funding, the charges from the unit-fund will be so small (as a result of smaller unit fund, and that charges are needed to slowly build the unit fund back up) that a negative non-unit reserve is not achievable?
     
    Last edited by a moderator: Aug 26, 2012
    bensondros, Aug 26, 2012
    #3
  4. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Actuarial funding is used when a high fund management charge is used to recoup initial expenses. It involves holding a lower unit fund than the published bid value of units. So we need to have a surrender penalty as a proportion of the unit fund in case of surrenders (see Mugono's comment below).

    Negative non-unit reserves are used when a low allocation rate on future premiums is used to recoup initial expenses. In this case the surrender penalty needs to be a monetary amount (as the charges are a percentage of the premiums rather than the fnd).

    In practice an insurer woould probably only use one of the above approaches for simplicity of calculation and to avoid having too many different charges (which reduces marketability).

    However, its possible to design a contract with both high management charges and low allocation rates and so use both approaches.

    Best wishes

    Mark
     
    Mark Willder, Aug 29, 2012
    #4
  5. bensondros

    bensondros Member

    Thanks for the response Mark.

    I still have some questions..

    Why is this the case? Is it because when allocation rate is low, more money goes into the non-unit fund initially, and so it is possible to make the non-unit reserve negative?

    Whereas if actuarial funding is used, even if the charges are high, the absolute amount from the unit fund near the start is low, so it's not quite possible to make the reserve negative?
     
    bensondros, Aug 30, 2012
    #5
  6. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    The non-unit reserve is the amount of money the regulator requires you to hold. It's calculated as the present value of the future charges less expenses (and other costs such as death benefits). So we can have a negative non-unit reserve if the value of future charges exceeds future expenses (which is the case if a low allocation rate applies to future premiums).

    The non-unit fund will initially be low (probably negative) but not quite for the reason you suggest. The initial expenses are high but charges at the start of the policy are small, which makes the non-unit fund negative at the start. The charges don't come until the future (whether they are future charges on premium allocation or fund management charges) so do not impact on the fund.

    An example may help. Consider initial expenses of 100, regular premiums for 6 years of 200 and allocation rate of 90%.

    At outset we recieve a charge on the first premium of 20 and pay expenses of 100. So the non-unit fund is -80.

    We calculate the non-unit reserve as the present value of the regular expenses (5 x 2 = 10 say) less future charges (5 x 20 = 100 ignoring discounting) to get a reserve of -90.

    So the good news is the fund is bigger than the required reserves and we are solvent.

    Best wishes

    Mark
     
    Mark Willder, Aug 30, 2012
    #6
  7. bensondros

    bensondros Member

    but surely, this would work just as well if we had high management charges and high allocation rate?

    If the allocation rate is 95%, we get 5 into the non-unit fund, so initially the non-unit fund is -95. Say the fund management charges are projected to yield 15,20,25,30,35 , sum of which = 125. The regular charges = 5x2 = 10.

    That would still give us the same good news.

    But why is it that negative non-unit reserves are used when a low allocation rate on future premiums is used? Is it because in this case, the profit will emerge in time to repay it?
     
    bensondros, Aug 30, 2012
    #7
  8. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Yes, we have enough future charges using your FMC example too. However, these charges are a percentage of the fund so we reduce the size of the fund using actuarial funding rather than negative sterling reserves.

    If we have a FMC of 5% each year for 5 years we could (approximately) reduce the units bought by 25%. So the first premium of 200 is paid, it suffers an allocation rate of 95% say, so the policyholder thinks they have a bid value of units of 190. Instead we only allocate 75% of it, so the actual unit reserve is 142.5. So the actual charge at the start is 57.5 (=200 - 142.5). This charge doesn't quite cover the initial expenses, but if we actuarially fund the second premium we will then have enough.

    We use negative non-unit reserves with reduced allocation rates because the charges are in monetary rather than unit terms. Yes, the negative reserve is effectively a policy loan and the future charges are used to repay it.

    Best wishes

    Mark
     
    Mark Willder, Aug 30, 2012
    #8
  9. bensondros

    bensondros Member

    Got it now :) thanks Mark!
     
    bensondros, Sep 1, 2012
    #9

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