Ch 18 -Embedded value doubts

[Actuary@22]

Hi

I have 3 queries in ch18-EV:

1.Section 3,please explain why the second condition is required for EV=Own funds.

In particular, if
1. there is no PVIF, and
 2.the company considers the Solvency II risk margin to be an appropriate measure of the
cost of residual non-hedgeable risks and the ‘lock-in’ cost of holding regulatory capital
then the embedded value will simply equate to shareholder ‘own funds’.

2.Under Experience Variances section 4, what is the basis of this expected experience over the year? Is it projection or valuation basis?

3.In the question given explain why changes in the projection or experience basis will not normally impact net assets, please explain the following part of the solution.Didnt understand this lock in concept.
"
There may, however, be an impact on the value of net assets if these are not taken at market
value but at a discounted or reduced value to take into account any ‘lock-in’, eg to cover
regulatory capital requirements. The pattern of release of ‘locked-in’ capital may be based on the
projection (or experience) basis assumptions, and so would be impacted by changes to that basis."


Thanks in advance!

 

[Lindsay Smitherman]

1.Section 3,please explain why the second condition is required for EV=Own funds.

In particular, if
1. there is no PVIF, and
 2.the company considers the Solvency II risk margin to be an appropriate measure of the
cost of residual non-hedgeable risks and the ‘lock-in’ cost of holding regulatory capital
then the embedded value will simply equate to shareholder ‘own funds’.

Hi - this is explained in the lower half of page 13 of that chapter.

The second condition listed above is that we assume that COHRC = RM
Therefore in the EEV equation, if we have RC = SCR + RM, then:
EEV = FS + RC - COHRC + PVIF = FS + SCR + RM - RM + 0 = FS + SCR = own funds

 

[Lindsay Smitherman]

2.Under Experience Variances section 4, what is the basis of this expected experience over the year? Is it projection or valuation basis?

The projection basis

 

[Lindsay Smitherman]

3.In the question given explain why changes in the projection or experience basis will not normally impact net assets, please explain the following part of the solution.Didnt understand this lock in concept.
"
There may, however, be an impact on the value of net assets if these are not taken at market
value but at a discounted or reduced value to take into account any ‘lock-in’, eg to cover
regulatory capital requirements. The pattern of release of ‘locked-in’ capital may be based on the
projection (or experience) basis assumptions, and so would be impacted by changes to that basis."

The question involves a traditional EV that is split into just net assets + PVIF. Net assets could be valued at market value, or alternatively could be valued at a lower value to allow for the fact that they cannot be distributed immediately. This is equivalent to valuing them by making a deduction for the frictional cost of holding required capital (the COHRC deduction that is explicit within EEV principles). If the projection basis which is used to calculate the 'COHRC deduction' changes, this would impact the valuation of the net assets (after that deduction).

 

[prachi]

Hi,

I have a query related to Embedded value.
If the new business is sold in the year, then SCR and RM will be set up. Analyzing the impact of these on EV.

1. This will lead to decrease in free surplus , as some of surplus will now be used to set up the SCR and RM which Will reduce EV.
2. The release of scr and rm will increase PVIF or the scr and rm after allowing for COHSC will increase EV.
But the impact of 1 is more than 2, hence EV will fall always ?

Is it correct?

 

[Lindsay Smitherman]

Yes (provided the insurer is indeed allowing for some kind of 'frictional' cost deduction within the EV calculation, which reflects the cost of having that capital locked in to cover the SCR & RM until the cohort runs off)