Asset share vs Reserve

Discussion in 'SP2' started by st2_taker, Sep 19, 2010.

  1. st2_taker

    st2_taker Member

    Hi,

    Is Reserve greater than Asset Share consistently? or vice versa?

    Why? :confused:

    Thanks for help.
     
  2. I will put forward my thoughts -

    Asset share is the value which the company holds till date i.e. the actual deposits in respect of a policy. However, (Prospective) Reserves are something which the company should hold to meet all its liabilities.

    Asset shares directly depends on what has actually happened in the past (ignoring any smoothing, adjustments) whereas Reserves are something which is based on the assumptions about the future and will largely depend on the actuary's views about the future.

    In principle, the Prospective reserves should be lower than the assets share for whole of the term of the policy. The exception to this is possible for few early years where the asset share is negative and the negative reserves may not be allowed to hold. I would also not say that for all the other years, the reserves will be consistently lower than the asset shares, because a sudden fall in the assets (say equity) can lower the asset share than reserves, but this may not be reflected in reserves as a fall in liabilities. This is more common for WP business.

    Reserves are targetted to meet just the benefit payments over time, so if everything happens as assumed, reserves will be equal to zero at the end of the term whereas the asset share would be greater than zero, the remainder representing the profits to the company.

    See the graph on Page 17, Chapter 22 which illustrates the relation between the asset share and the rerserves.

    Hope it helps.
     
    Last edited by a moderator: Sep 19, 2010
  3. jeetenge

    jeetenge Member

    Asset Share vs. Retrospective Reserve

    Prospective Reserves are the reserves based on the assumptions about the future, however the Retrospective Reserves are the reserves based on what happened in the past.

    The calculation of Asset Share and Retrospective Reserve are similar and components used in both calculation are same. Then how does Asset share differ from Retrospective Reserve.
     
  4. mugono

    mugono Ton up Member


    The short answer: Asset shares are retrospectively calculated. It is a retrospective 'reserve' by definition.
     
  5. mittalp

    mittalp Member

    Hi,

    If interest rate is more affecting the asset part as compared to liabilities then how does this justify that reserves consistently greater than asset share or not?

    Please clarify.

    Thanks
     
  6. Lindsay Smitherman

    Lindsay Smitherman ActEd Tutor Staff Member

    Hi - I am not sure that I fully understand your question.

    Let's assume we are talking about conventional without-profits business so that the backing assets are fixed interest bonds.

    If bond yields increase, the values of the bonds fall. So the value of the assets (and thus the value of the asset share) falls. But the discount rate that we can use in a prospective reserve calculation will increase due to the higher bond yields, so the value of liabilities (ie reserves) also falls.

    If the assets and liabilities are perfectly matched, the reduction in asset and liability values will be the same. However, in reality it is unlikely that the matching is perfect. So, for example, if the liabilities are of longer duration than the assets, the fall in value of the liabilities will be greater than of the assets.

    Does that address what you are asking about? If not, please could you rephrase the question? thank you
     
  7. mittalp

    mittalp Member

    Asset share is the value which the company holds till date i.e. the actual deposits in respect of a policy. However, (Prospective) Reserves are something which the company should hold to meet all its liabilities.

    Asset shares directly depends on what has actually happened in the past (ignoring any smoothing, adjustments) whereas Reserves are something which is based on the assumptions about the future and will largely depend on the actuary's views about the future.

    In principle, the Prospective reserves should be lower than the assets share for whole of the term of the policy. The exception to this is possible for few early years where the asset share is negative and the negative reserves may not be allowed to hold. I would also not say that for all the other years, the reserves will be consistently lower than the asset shares, because a sudden fall in the assets (say equity) can lower the asset share than reserves, but this may not be reflected in reserves as a fall in liabilities. This is more common for WP business.

    Reserves are targetted to meet just the benefit payments over time, so if everything happens as assumed, reserves will be equal to zero at the end of the term whereas the asset share would be greater than zero, the remainder representing the profits to the company.

    See the graph on Page 17, Chapter 22 which illustrates the relation between the asset share and the reserves.

    Could you please explain the highlighted part in green? Why a fall in interest rate is not reflecting in liabilities as it is reflecting in asset share.
     
  8. Lindsay Smitherman

    Lindsay Smitherman ActEd Tutor Staff Member

    The first part of this is as illustrated in the graphs in Section 5.2 of Chapter 21 (and as explained through that section). However, to pick up on the point in green, as also illustrated in the graphs the asset share might be negative early on (due to high initial expenses relative to premiums received). However, if we are considering a comparison against supervisory reserves, it is possible that the supervisor might not allow a negative reserve to be held. In which case, the prospective reserve would be zero - and would thus be higher than the asset share (which is negative).
     
  9. Lindsay Smitherman

    Lindsay Smitherman ActEd Tutor Staff Member

    What this is saying is that we cannot say that, even later on, prospective reserves will always be lower than asset shares. For example, if expense performance has been very poor the asset shares (reflecting actual experience) will be lower than they would have been, but the reserves might even be higher than they would have been (increased assumed future expenses). So we could end up with asset shares < prospective reserves.

    Another example is as expressed here, ie if we are thinking about with-profits business. These policies will be normally be significantly invested in equities. If equity values fall, the asset shares will fall. However, the liabilities might not fall by as much because (a) the benefits are smoothed (so the whole equity value fall is not necessarily reflected in the benefits expected to be paid) and (b) the fall in asset shares makes it more likely that the inherent guarantees (sum assured & bonuses declared to date) will bite, thus increasing the cost of guarantees part of the liability.

    Point (b) would also be true, say, for unit-linked business with minimum payment guarantees.

    Thanks for clarifying what you were referring to. Does this address your concerns now?
     
  10. mittalp

    mittalp Member

    Apologies for confusion and thanks Lindsay Smitherman for understanding my concern. It helps me a lot.
     
  11. Lindsay Smitherman

    Lindsay Smitherman ActEd Tutor Staff Member

    You're welcome & am glad we got there in the end - sorry it took me a while to get it!
     
    mittalp likes this.
  12. nikita agarwala

    nikita agarwala Keen member

    Hi @Lindsay Smitherman, could you please help understand this statement that you mentioned above "So, for example, if the liabilities are of longer duration than the assets, the fall in value of the liabilities will be greater than of the assets."

    Thank you. Appreciate all your help!
     
  13. Lynn Birchall

    Lynn Birchall ActEd Tutor Staff Member

    Hi Nikita

    In the example, we're talking about conventional without-profits business with backing assets are fixed interest bonds.

    If bond yields rise:
    the value of the assets (ie the bonds) falls - because this is the present value (PV) of the bond cashflows discounted at the bond yield.
    the value of the liabilities falls - because this is the PV of the expected future benefits / expense cashflows discounted at a discount rate determined from the bond yield.

    How much impact a change in the discount rate has on a PV calculation depends on the duration of the cashflows - the further in the future the cashflows are, the greater the period over which they are being discounted and so the greater the change in the PV.

    So, if the liability cashflows have a longer duration than the assets, the PV of the liabilities is more sensitive than the PV of the assets to a change in the yields.

    Hope this helps
    Lynn
     

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