Hello, For Q1, part i) Text from the question below for reference- then roll the model forward to the new valuation date using actual investment returns for the inter-valuation period and the year-end discount rate based on the updated asset yields Does this not mean economic assumption change instead of variance (the solution says its economic variance) in analysis of surplus? If run the model with the new longevity, followed by new expense assumptions is classified as non-economic assumptions change, I didn't understand why would the investment part wouldn't be economic assumptions change. By definition, 'variance' is the comparison of actual vs expected assumption. Please help in understanding the gap in my understanding here. Thank you!
Hi - this is a good question! Hopefully you are comfortable that the roll forward 'using actual investment returns for the inter-valuation period' does represent an economic variance? This is the same as rolling forward using actual mortality / expenses etc rather than expected. Typically, an insurer would combine this impact with the impact of the change in yield at the year-end, ie the change in discount rate. Although I agree that this sounds more like an assumption change, it makes sense to include them together. That's because a fall in yields will result in an increase in the market value of assets, which will come through as a positive 'investment return experience variance'. However, we need to bear in mind that the liabilities are being discounted using the actual yield on assets (for this question, this means the annuity liabilities and non-unit reserves). So a reduction in yields will also result in an increase in the value of liabilities, and this should broadly offset the increase in the value of assets - at least to the extent to which assets and liabilities are matched. The increase in liabilities is a negative component within the analysis of surplus. So rather than showing a big positive economic experience variance item and a separate big negative assumption change item, the insurer would normally combine these. Thus the only impact coming through in the analysis of change is any profit / loss arising from the assets and liabilities being mismatched. This gives a much more useful analysis. Hope that helps.
Thank you Lindsay! This was helpful. Another follow up question below- Wouldn't the impact on analysis of change (in surplus) finally be profit/loss from assets and liabilities being mismatched (as you explained using fall in yield example) + impact of actual investment return ? Not having practical experience here is proving to be difficult. Please elaborate a bit on the conclusion, if possible. Thanks again!
Think about splitting the assets into two parts: the assets backing the liabilities and the remainder, ie the surplus assets. For the assets backing liabilities: the only impact on the surplus arising of the actual investment return earned comes from any mismatching of those assets and liabilities. (If the assets and liabilities are precisely matched, the investment return earned on assets will be exactly offset by the change in value of liabilities.) For the assets backing the surplus: yes, the actual investment return earned on these assets falls fully into surplus arising.
