Apr 2007 Q2(iv)

[bensondros]

This question concerns the calculation of the CRR, given the surplus on Peak 1,2 LTICR, RCR and RCM.

The question states that the firm has WP liabilities of £650m, so it's a realistic-basis firm.

According to the core reading, there is no need for a realistic-basis life firm to hold and RCR, so why does the calculation involve the RCR? Is it because it has without profits liabilities?

Secondly, say if the firm is a proprietary rather than a mutual, and writes without-profits business in one fund, and WP in another (with >£500m liabilities). Will it calculate the CRR for each fund separately and then sum them up?

Lastly, how is the realistic asset value for Peak 2 calculated? In the non-core reading notes, it says admissible assets + excess admissible assets + PVFP on any without-profits business written in the WP fund - any assets backing without-profits business written in the WP fund.

For this last term (any assets backing without-profits business written in the WP fund), does this include the capital requirements for the without-profits business? This will probably explain the first question too..

 

[Mark Willder]

This question concerns the calculation of the CRR, given the surplus on Peak 1,2 LTICR, RCR and RCM.

The question states that the firm has WP liabilities of £650m, so it's a realistic-basis firm.

According to the core reading, there is no need for a realistic-basis life firm to hold and RCR, so why does the calculation involve the RCR? Is it because it has without profits liabilities?

Secondly, say if the firm is a proprietary rather than a mutual, and writes without-profits business in one fund, and WP in another (with >£500m liabilities). Will it calculate the CRR for each fund separately and then sum them up?

Lastly, how is the realistic asset value for Peak 2 calculated? In the non-core reading notes, it says admissible assets + excess admissible assets + PVFP on any without-profits business written in the WP fund - any assets backing without-profits business written in the WP fund.

For this last term (any assets backing without-profits business written in the WP fund), does this include the capital requirements for the without-profits business? This will probably explain the first question too..

Good spot. When this question was set, the twin peaks rules were slightly different. But you are quite right, the RCR is now zero for realistic basis firms.

Even if the company has separate funds, it still doesn't need to calculate an RCR under the current rules. So Pillar 1 Peak 1 reserves are calculated for each fund (with RCR = 0). Peak 2 reserves are then calculated for each fund containing with-profits business and the WPICC is calculated for each. The surplus is then summed over the surplus of each fund.

I think your other questions are cleared up once we allow for the changes to the twin peaks rules since this question was set.

Good luck with the exam.

Mark

 

[bensondros]

Thanks for the reply Mark, but I still have some questions:

1. It doesn't seem quite fair that if a company is a realistic-basis life firm, then it doesn't have to hold RCR for the funds that don't have WP business in them. Say if a regulatory-basis life firm has written £100b of without-profits business. The RCR is probably a significant amount. Then the company acquires a mere £500m of WP business, and is now a realistic-basis life firm. All of a sudden it no longer needs to hold the RCR?

2. So RCR is not needed, but what about LTICR? Is LTICR included in 'any assets backing without-profits business written in the WP fund' when calculating the Peak 2 reserves?

 

[Mark Willder]

1. It doesn't seem quite fair that if a company is a realistic-basis life firm, then it doesn't have to hold RCR for the funds that don't have WP business in them. Say if a regulatory-basis life firm has written £100b of without-profits business. The RCR is probably a significant amount. Then the company acquires a mere £500m of WP business, and is now a realistic-basis life firm. All of a sudden it no longer needs to hold the RCR?

I completely agree with you. I can't see the logic to these rules either.

I imagine that there are no firms with enormous books of without-profits and only just 500m of with-profits. The regulator would quickly change the rules if a company deliberately held with-profits business to manipulate the calculation as you suggest.

2. So RCR is not needed, but what about LTICR? Is LTICR included in 'any assets backing without-profits business written in the WP fund' when calculating the Peak 2 reserves?

Page 11 of Chapter 11 says:

"The valuation of assets in the Peak 2 calculation is described in Chapter 12. However, to make sense of some of the Core Reading in this chapter it is helpful to cover them briefly here. The main components of the realistic assets are:

admissible assets (from Peak 1)

+ any excess admissible assets (ie assets that exceed the percentage limits for admissibility described in Chapter 12)

+ the present value of future profits (or losses) on any without-profits business written in the with-profits fund. INSPRU specifies rules governing this calculation of the present value of future profits

– any assets backing without-profits business written in the with-profits fund. This should include the related solvency capital if its release is included in the future profits above."

So yes, the LTICR can be included as part of the solvency capital mentioned in the last part above, but its release over time will also be included in the profits in the penultimate part above.

Best wishes

Mark

 

[bensondros]

Hah..spotted a loophole in the regulation. That's a first for me.

Thanks for pointing that out, don't know how i missed it..