Asset Share and Future Policy-Related Liabilities

Hi,

I think I'm getting a little confused about this, hope someone can help.

Under Peak 2, the realistic value of liabilities is made up of the With-Profits Benfit Reserve + Future Policy Related Liabilities (+ Current Liabilities)

The notes say that the cost of options/guarantees/smoothing needs to be allowed for in the Future Policy-Related Liabilities to the extent that it is not already allowed for in the With-Profits Benefit Reserve.

a) If the full cost of options/guarantees/smoothing is deducted from the asset share, then there would be no component for that in the future policy-related liabilities. So the reserve would be the asset share less the cost of options/guarantees/smoothing. That would make sense if the policyholder is charged for this cost and is then paid less on maturity,etc.

b) Now if no cost of options/guarantees/smoothing is not deducted from the asset share, it would have to be allowed for in the future policy-related liabilities. In that case the reserve would be the asset share plus the cost of options/guarantees/smoothing. That makes sense from the point of view that the reserve would need to be higher due to the fact that there is such a future cost.

Surely the resulting reserve should be the same, no matter which component the cost is allowed for in? a) seems more sensible from a payouts perspective but not realistic in terms of reserving (b).

What am I missing?

 

I would say that in (a) you are charging the policyholders for these costs (by deducting them off the asset share) but not so in (b) - the insurer is taking the cost for these.

 

Hi,

Thanks, agreed. What I'm confused about though is the apparent (and this is where my logic is probably failing) difference in the size of reserves between the approaches of a) and b). Shouldn't the insurer's reserves be the same whether the policyholder is being charged for the cost or not?

 

My current understanding (as I am studying for the exam) is that a reserve has to be held for options/guarantees. However asset shares should pay for this reserve as in (a). So I would say that to the extent that this reserve is not offset against the asset shares it should be held as a reserve (b) (funded from free assets). Asset shares should also be charged for the opportunity cost of holding these additional reserves and any related capital requirements.

The one reason I can think of why asset shares are not adjusted for the full cost is in situations where asset shares are too small or negative (early on) to pay for the full cost.

So my answer to your question is that the total reserves would not be the same if you have not charged policyholders (reduce asset shares) for what they should be paying for.

Hopefully my understanding is ok

 

Sounds good to me