April 2013 Q4(i)

[Contacts119]

Hi,

I understand the the main risk to the company is that at the point of exercise the value of the backing assets will be insufficient to meet the guarantee, but I am getting confused on the interest rate movement.

Please can someone explain the following from the examiners' report?

"The company might decide to hold fixed interest investments which match the maturity lump sum benefits by term. In this case, the risk is from interest rates at the guarantee date being lower than those used within pricing."

I also do not understand the concept of investing as a deferred annuity and then "There is now also a risk that more policyholders opt for the lump sum benefit than expected at a time when yields are high"

Many thanks.

 

[Lynn Birchall]

Hello

Taking your second point first: Imagine the company invests to match the annuity payments. It then has the risk that the lump sum benefit is more valuable than the annuity payments & that more policyholders than expected tale the lump sum option. The lump sum option will be more valuable when yields / interest rates are high (as the discounted value of the annuity payments will then be lower).

Alternatively, the company could be holding bonds to match the lump sum benefits. The risk then is that interest rates are low, which would worsen the annuity terms the company would wish to offer & make the guaranteed annuity rates more valuable.

Hope this helps a little
Thanks
Lynn