Analysis of EV

Yes, experience variances are the differences in actual versus expected experience over the year.

Assumption changes will affect the cashflows you expect to have in future years (so the value of your in force will change).

We should use the same list for both experience variances and assumption changes, eg mortality, investment, expenses, withdrawals.

Embedded values have two parts:
net assets
value of in force

So the change in EV also has two parts:
change in net assets
change in VIF

If the EV projection assumptions are changed then the VIF will change.

If the reserving basis strengthens then the net assets will decrease, but the VIF will increase.

The VIF will increase each year with the unwinding of the risk discount rate.

However, the VIF referring to cashflows over the last year will then fall into the net assets. If actual experience was better than expected then the net assets will be higher than expected.

If investment return is higher than expected then net assets will be higher than expected.

Yes, that's correct.

Best wishes

Mark

 

Hi

Yes, you are correct that the main impact will be in relation to unit-linked business. However, it won't just be due to any fund-related charges (although this will be a significant component). The VIF will also be impacted for products on which there is a financial guarantee or option (such as a UL product with a minimum guaranteed value at maturity). Economic experience over the year will impact the extent to which such a guarantee / option is in- or out-of the money and therefore what it is expected to cost the company.

There will also be impacts on VIF for with-profits business. If shareholder transfers are based on a % of bonuses, then good investment performance over the year will increase the amount of bonus that the company would expect to pay in future, hence the VIF would increase (and vice versa if poor investment performance). The impact of guarantees / options biting will also be relevant here.

Impact on VIF is less likely for conventional without-profits business, although there may be products with an inherent option that could be impacted (eg deferred annuity with option to convert the annuity into a cash lump sum, which could be expected to be more or less costly following changes to interest rates during the year).

However, there is also a secondary issue that separating out investment experience during the year and changes to economic assumptions is not necessarily straightforward. For example, if interest rates fall during the year then the values of bonds now will increase (thus increasing the value of assets) but there will be lower expected returns on these assets going forwards. Lower interest rates would impact the value of liabilities, thus the release of liabilities component of the VIF, and the expected investment earnings component of the VIF would also be impacted by both changes in the amount of liabilities and changes in the assumed future investment returns (if backed by bonds). Should these latter aspects be classified as being due to economic experience during the year or as a change in assumptions? Since they are so closely related to each other, some companies in the UK would consider them together in an analysis of surplus or EV - but some would keep them separate.

So that wasn't a particularly easy thing to answer, but I hope it has shed a bit more light on what the VIF impacts could possibly be. The important thing is that your base instinct is correct: that is indeed the main likely component of that item of change.

 

That's what they pay me for! Glad it helped you