Hi everyone, I've attempted this question using ASET and was confused by the solution given. The question asks how adopting the valuation basis will impact the risks faced by the company, however a considerable part of the solution focuses on the investment (and liability matching) risks associated with investing in bonds. I appreciate and understand these risks, but struggle to see how they are affected by this specific valuation basis, beyond the use of market values. For example, the following points are given: Rationale for the use of bonds Use of index-linked bonds to match real cashflows Credit risk I was expecting detail on the following (which are affected by the basis, but not in the solution): Volatility of the liability values due to a government bond discount rate Impact of best estimate early surrender assumption, in particular new business strain, loss of investment return from holding cash assets and general liquidity risk Discussion around basis typically used for solvency Please could someone help clarify how I have misinterpreted the question? Kind regards, Oscar
I was doing this question today too, and I didn't understand the bit where it was speaking about it being single premium, and the risk that if we use a discount rate that is too high. It then goes on to talk about the fact that if it was regular premium, the risk wouldn't be so big. I don't really understand the explanation given around offsetting effects - could someone explain this to me? Thanks, Fran
I think the difference is that with a regular premium product, the future outgo from liabilities will be offset to some extent by inflow from premiums. That means the effect of discounting using a more optimistic basis is less pronounced than with a single, up front premium where the net cashflow at future times will be greater (so the discount rate is applied to a 'larger' net liability value).
The focus of the solution is around bonds because of the annuity business that is being written. When the question talks about the "adoption of this basis", it's not just referring to the best estimate basis of the assumptions, but also to the use of the government yields for discounting. You've mentioned a good list of possible risks - but they may not be applicable to this case. You might not expect the risk-free rate to vary too much - only under extreme conditions. The early surrender assumption isn't likely to be required because policyholders rarely surrender annuities (or any single premium product). The question is quite specific around which basis it wants you to look at. I hope some of that is helpful in interpreting the question? Please reply if it's not satisfactory
Hi, thanks both for your responses - this question makes a lot more sense to me now. I have a question on guaranteed annuity rates - basically can someone explain the relationship between annuity rates and bond yields? I am a bit confused about if bond rates fall why that would mean annuity rates reduce? Is this because they can be viewed as substitutes? Also does an insurance company usually guarantee annuity rates? Thanks, Fran
And also the relationship between DC schemes and guaranteed annuity rates! Is it up to the insurer to "top up" the DC fund for a member if it has guaranteed the annuity rate if annuity rates have fallen unexpectedly for example?
This would be some sort of defined ambition arrangement whereby the risks are shared between the sponsor and member. So in this case it would be the sponsor (not the insurer) who effectively tops-up the fund for the member.
Thanks Steve - much clearer It's sometimes seems as though understanding what the question wants is the hardest part of CA1!
