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April 2018 Q7 i)

M

Muskan Hamirwasia

Keen member
Hi,

The examiner's report in 7 i) states the following

Not exceeding earned asset shares, in aggregate, over a reasonable time period. Using a prospective, rather than retrospective, method means that there is no guarantee that this principle will be met.

How will using a prospective reserve not guarantee this principle being met but retrospective reserve will? Could you explain a bit in brief the meaning behind this point. Prospective reserves would not be efficient in the earlier durations while retrospective reserves would not be accurate during the later durations right? So on what basis are we comparing retrospective vs prospective reserves here?
 
Hi

Asset shares depend on actual past experience. They are therefore unpredictable and potentially volatile, eg asset shares can drop sharply if there's a market crash.

The question tells us that the prospective approach in this case is based on best estimates, ie best estimates about the future experience. There's no guarantee that these will change just because the asset share has changed. So, we can't be sure that our prospective liability valuation will be less than the asset share.

A retrospective method to calculating surrender values is one based on asset shares (or a retrospective reserve done using actual past experience as a proxy to asset shares). This will therefore behave like the asset share and drop when the asset share drops, so we can be sure that the surrender value will not exceed asset share.
 
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