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Analysis of EV

J

joe90

Member
Any help on this would be appreciated!

First of all I would like to know the difference between experience variances and operating assumption changes? Are experience variances the difference in lapses, mortality, expenses vs actual over the year? Are operating assumption changes just changes in the values of these assumptions in the basis over the year? What is a list of operating assumption changes(a broad one anyway)


When doing an analysis of ev it talks about 2 elements. 1) Profit emerging during the year 2) value of IF at end of the year.

What is the profit emerging during the year? Is it the unwind of the risk discount rate, experience variances, operating assumption changes, investment return variances, economic assumption changes and all other items that may contribute to profit over the year?

Is the VIF at the end of the year just the value of in force business on the new basis at the end of the year?

Cheers
 
First of all I would like to know the difference between experience variances and operating assumption changes? Are experience variances the difference in lapses, mortality, expenses vs actual over the year? Are operating assumption changes just changes in the values of these assumptions in the basis over the year? What is a list of operating assumption changes(a broad one anyway)
Click to expand...

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.

When doing an analysis of ev it talks about 2 elements. 1) Profit emerging during the year 2) value of IF at end of the year.

What is the profit emerging during the year? Is it the unwind of the risk discount rate, experience variances, operating assumption changes, investment return variances, economic assumption changes and all other items that may contribute to profit over the year?
Click to expand...

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.

Is the VIF at the end of the year just the value of in force business on the new basis at the end of the year?
Click to expand...

Yes, that's correct.

Best wishes

Mark
 
Hi Mark

I am from South Africa and it is mentioned in our notes that:
“the difference between VIF(1) actual and VIF(1) expected can be ascribed to:
- value of new business
- operating experience variances
- operating assumption and model changes
- investment return variances
- economic assumption changes”.

I understand all of these except the “investment return variances” part. In my mind this will only impact ANW (Free surplus + Required Capital), since it affects the profit earned over the reporting period but not future s/h cashflows. The only exception I can think of is unit-linked business, where unit growth is different to expected and that would impact future investment charges in VIF(1). Can you perhaps explain how it can otherwise impact the VIF?

Thanks in advance for the help.
 
Last edited by a moderator:
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.
 
Hi Lindsay

I am amazed by the way you are able to explain such complex concepts in a clear, simple way! Thank you so much.
 
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