Hi, I'm quite confused by the statement in chapter 11 which says 'credit can be taken for the present value of future s/h transfers and other internal transfers to s/h owned fund...and can be deducted from the WPICC'. My questions are: 1. shareholder transfer is included in the benefit reserve in Peak 2 calculation whilst it's not included in the realistic assets (because it's inadmissible?), then why are we deducting it from WPICC to increase the surplus in Peak 1 instead of increasing realistic assets directly by that amount? 2. WPICC can only be reduced and to the extent that it's greater than zero. In this case, the realistic peak is biting so is it meaningless to increase Peak 1's surplus because in the end WPICC exists and Peak 2 is still the more stringent peak? Am I correct to say that "more stringent one" means the peak which provides the smaller surplus and as long as a WPICC exists, the Peak 2's result should be the more stringent one and should be taken as the result under Pillar 1? 3. In my understanding, the figure shown in the FSA return is calculated by deducting the two transfers values (Form 18 line 64 &65) from the difference of the regulatory excess capital and the realistic excess capital. But according to CR, shouldn't we add line64 and 65 back to the regulatory excess capital? Much appreciated if anyone can make it clear for me.
WPICC and Shareholder transfers under Pillar 1 First, a general description of how s/h transfers affect the various components of Pillar 1: Shareholder transfers will affect the WPBR in Peak 2. If this is calculated using a retrospective method, past s/h transfers will be deducted when deriving the asset share and also future transfers in respect of surplus already credited to asset shares but not yet distributed as bonus. If the WPBR calculation is prospective, then only future s/h transfers will need to be allowed for. [See Chapter 14, Section 2.1] INSPRU 1.3.105R(7) requires future s/h transfers to be included in the realistic value of liabilities under Peak 2. So to the extent that they are not already allowed for under the WPBR, they will be shown under FPRL in Form 19, Line 47 “Other long-term insurance liabilities”. (This line may also include mis-selling reserves and provision for tax.) The present value of future s/h transfers under the most adverse RCM scenario is shown in Form 18, Line 64. [See Chapter 11, Section 3.4] The fact that these future s/h transfers are included as a liability of the fund, but are not included within s/h assets is a bit harsh, so the rules allow this value to be deducted from the WPICC that would otherwise have to be held, subject to having a minimum WPICC of zero. Now, back to your specific questions: 1. You could look at it that way - it's just a different presentation. Increasing realistic assets would increase realistic surplus and therfore automatically lead to a lower WPICC. But the increase in assets would depend on the results of the RCM scenarios and I guess they want the reported assets figure to be independent of these. 2. Your interpretation of "more stringent" is correct. 3. Yes, the WPICC shown in the FSA returns is Max{Peak 1 surplus - Peak 2 surplus - future transfers , 0}. When the CR says credit can be taken for these transfers, it means they can be used to reduce a positive WPICC, not that they should be added to Peak 1 assets. So it's not a circular argument. The Peak 2 surplus in the formula above doesn't have these transfers added in.
Thanks for such a detailed explanation, Mike. But I'm still a bit confused on the purpose of the WPICC as there's a paragraph in ch11 saying that "Therefore, the WPICC can be reduced (and so the Peak 1 surplus increased if the realstic peak is biting) by the present value of these future transfers." Actually, it is the statement in the bracket that bothers me. Maybe it is easier to present my question by using an example: Let us assume that we have the following figures: LTICR = 50 Peak 1 surplus = 100 Peak 2 surplus = 50 PV of future transfer = 20 Then we have a WPICC equal to 30. But what happens next? The Peak 2 is the more onerous one and we end up with a CRR of 80 and a Pillar one surplus of 50? What to do with the increase in Peak 1 surplus at all cuz it's still the Peak 2 surplus that we are using?
Ok, based on your numbers and ignoring the future transfers, the WPICC would be max(100-50,0)=50 leading to a revised Peak 1 surplus of 50. The Core Reading is saying that, compared with this, the effect of the future transfers is to reduce the required WPICC down to 30 and to increase the revised Peak 1 surplus up to 70. As you say, this gives a CRR of LTICR+WPICC=50+30=80 We don't go back and look at Peak surplus again. The only point of Peak 2 is to determine the size of any WPICC. When we have this, we go back to Peak 1 to look at the CRR and remaining surplus. So the Pillar 1 surplus, based on Peak 1 admissible assets and MR+CRR is 70.
Hi Mike, another question here. Could you please explain further the deferral of surplus distribution on the captital requirement? It's discussed in Question 26.1 and also mentioned in ch25 that less guaranteed benefits will reduce the overall Pillar 1 capital requirement unless Peak 2 is biting. I don't see the point in the solution to question 26.1.
Increasing the deferring of surplus means declaring lower regular bonuses, which will cause mathematical reserves to increase more slowly. Under Peak 1 (in isolation), this will increase free assets, ie regualtory surplus. But in Q26.1, we're assuming Peak 2 surplus is lower than Peak 1 surplus and so a WPICC is needed to bring Peak 1 surplus down to being the same as that for Peak 2. So increasing the initial Peak 1 surplus in this way doesn't help us - it just means a higher WPICC is needed to get the surplus down to the same Peak 2 surplus as before. (There's also a mention of the effect on FPRL, but the above is the main point to grasp.)
