Hi there Under the Fairness of Distribution section, the first point explains how cost of guarantee or cost of smoothing that are charged to the asset share make a contribution to the estate. In working through the earlier asset shares chapter, I had not thought about where these "costs" go to once deducted from the asset share. Please could you also help point me any reading (if any) that refer to this process of contributions to the estate. Why does it get paid into the estate? Is this because the estate is meant to cover any shortfall between asset share and the payout due? If so, conceptually how does the excess/ shortfall paid relate to the cost of guarantee or smoothing if its deducted from asset share but paid out of estate anyway if the asset share is too low. Many thanks
Estate = realistic value of assets - realistic value of liabilities (in the WP fund) WP realistic liabilities = asset shares + expected cost of options/guarantees (+ maybe cost of smoothing) So if something is deducted from asset share, by definition it ends up in the estate (asset share smaller by X -> estate bigger by X) A charge for the cost of options/guarantees may be deducted from asset shares. These charges accumulate within the estate, so that when an option or guarantee actually bites, the accumulated charges can be used to pay that cost (ie the excess of the guarantee/option amount over asset share). The company would aim, over time, to take approx enough charges from asset shares to cover the actual costs, bearing in mind that the latter tend to be quite 'lumpy' (the actual cost would typically be zero, but then could be quite significant at times when the guarantee/option bites).
Thank you Lindsay. Is it then expected that the asset share will exceed the guaranteed payout in most cases? But will apply to a group of policies where there is offsetting of the experience? I am getting confused about why the asset share is reduced by the charges but then charges are "paid back" from the estate if the guaranteed payout is higher than the asset share. When this happens, is this because there is risk pooling happening in the WP fund?
Yes, normally the asset share would be expected to exceed the guaranteed benefit. And yes, this is a form of risk pooling. If charges for the cost of guarantees are taken from asset shares (and that isn't necessarily the case) then everyone pays them. But only some people will then gain any 'benefit' from what those charges are covering, ie those who claim at a point when the asset share has fallen below the guaranteed claim amount.
