Hi, page 13: it states that ... "Net Premium Valuation is preferred for conventional with profits business as it does not result in the capitalisation of basis differences ... For example, with a gross premium valuation, the actuary might assume a future bonus rate that is lower than the bonuses that are supportable by the business, on the valuation assumptions, thereby capitalising the additional profit expected to be earned from the future gross premiums" I am particularly confused with the bold statement. How can we capitalising the additional profit if we assume a future bonus rate that is lower than the bonuses that are supportable by the business? Thanks for help in advance!
In the situation described, we're reserving for a low bonus, but deducting premiums that are expected to generate higher bonuses. So overall, the effect is to hold lower reserves (than if there were no allowance for bonuses in benefit reserves and premiums) and thereby increase the free assets and so reported shareholder profits (if proprietary). But this is misleading, because when the extra surplus does emerge it will be used to award bonuses at some point and so is not all shareholder profit.
