The notes in the first para here state that 'The unit fund and asset share can then be quite different, depending on the charging structure, and there is no reason why the unit fund should not considerably exceed the asset share, particularly near the start of a contract.' This makes a lot of sense intuitively. I'm just trying to understand what this would mean for the non-unit reserve reserve near the start of the contract. Does this stay negative? Can non-unit reserve be negative? Would this need to be met by the shareholders?
Hi Kanishka A numerical example may help to make this clearer. Consider a unit-linked contract with single premium of 100, initial expenses of 10, renewal expenses each year of 1. There is a 95% allocation rate, so the charge at the start of the contract is 5. There is a policy fee at the end of each year of 2. The asset share at the start of the contract will be the premium of 100 less the expenses of 10, so the asset share at the start is 90. The unit fund at the start of the contract will be the premium of 100 multiplied by the allocation rate of 95%, so the unit fund at the start is 95, ie the unit fund exceeds the asset share. If we ignore any capital injection by the shareholders, then the non-unit fund at the start will be the charge of 5 less the expenses of 10. So the non-unit fund at the start will be -5. What happens next depends on the reserving regulations and this is covered in detail in chapter 19, but I can show you briefly below. The regulations might say that the non-unit reserve must be non-negative. In this case the shareholders would have to inject capital into the non-unit fund to make it at least as large as the reserves. But the regulations might say that a negative non-unit reserve is ok. The policy fee each year of 2 is bigger than the future expenses of 1, so the discounted value of the future liabilities is negative. In this case it might be ok to have a negative non-unit fund, but certain conditions may need to be met, eg there may need to be a surrender penalty to recover the initial expenses. Best wishes Mark
