Asset Share and Prospective Reserves

[mittalp]

Can someone explain how asset share behaves in comparison to the prospective value of policy. Does prospective reserves is always greater than asset share of policy or less than or equal to?

Thanks
Prashant

 

[Lindsay Smitherman]

Hi - the basic answer is that it depends! In particular, it depends on both actual experience to date and the basis on which the prospective reserve is valued.

Let's assume that we are talking about conventional without-profits business, which is what the chapter on surrender values considers (assuming that is the area which has raised this question for you).

The asset share depends on actual experience to date. If this has been poor (eg high expenses, low investment returns) the asset share will be low and may be lower than a prospective reserve. However, if actual experience to date has been good (eg low expenses, high investment returns) then the asset share may be higher than a prospective reserve.

The prospective reserve will depend on the assumptions used in the valuation. If these are best estimate, the prospective reserve might be quite low - and thus more likely to be lower than the asset share. If the assumptions used contain significant margins (eg as would be the case if they were in line with a pricing basis wherein the margins represent the profit loadings) then the prospective reserve might be quite high - and thus more likely to be higher than the asset share.

So the overall comparison depends on both the actual experience achieved to date and the prospective valuation basis used.

If actual experience has been in line with the original premium basis (with profit loadings = margins, as above) and the prospective valuation is performed on the same basis, the two amounts will be the same. This is explored in Q2 of the April 2015 ST2 exam, which also goes on to consider the impact of actual experience differing - so you might find it helpful.

See also Chapter 21 Section 5.2 (including the graphs), which considers the comparison between the two measures in the context of setting surrender values.

Hope that gives you enough to help you with this issue.

 

[mittalp]

Thanks for your reply. It helps me a lot. But there is one question.

Let's suppose your actual experience is quite good but the margins used for the calculation of prospective reserve is more prudent with high loading. If this will be the case then company will get high prospective value and quite low asset share and if co. decide to give surrender value by choosing prospective value method. Then it seems something wrong here.

May be i am on wrong path. please correct

Thanks
Prashant

 

[Lindsay Smitherman]

This whole issue of whether to use a retrospective method or a prospective method, and if the latter then what basis to use, and consequently how much profit the company therefore ends up taking at surrender, is what is covered in some detail in Chapter 21 of the Course Notes.

This is why, for example, companies might use a retrospective approach at early durations but then blend into using a prospective approach at later durations (as described in Section 5.1). Or why the company might use a prospective approach on the original premium basis at earlier durations, blending into a prospective approach on a best estimate basis at later durations (as described in Section 5.2).

I would recommend having another thorough readthrough of that chapter, as it aims to highlight these sorts of issues that you have raised here.

BTW I think you have your argument the wrong way round? If 'actual experience is quite good' then the asset share would be quite high, not quite low.

In the example that you have given, if the company set prospective surrender values using the original pricing basis (with prudential margins loaded into assumptions) then the company would keep the profit that has been generated to date (including through the good actual experience) but would be giving away future profit margins. If it set prospective surrender values using a best estimate basis, then it would be keeping profit generated to date and the future profit margins that it was expecting to get had the policy stayed to maturity. If it set surrender value = asset share then it would be keeping no profit. (This is as covered in Section 5.2 of the chapter.)