Hi, looking at practice question 21.3 part (iii) we are asked to describe the problems caused by a share increase in interest rates. We are told the earned asset share may fall as the market value of assets will fall? we are also told in the answer “ current premium rates me be lower” question: 1) why does a rise in the interest rate cause a fall in the market value of assets. And hence why would this fall in the market value of assets cause the asset share to fall. We use AS(t+1) = AS(t) * (1+i) …. So I think I am confused here as I thought the increase in interest rates would actually increase the asset share. 2) why would premium rates be lower now as a result of this interest rate rise ? thanks for your help
Hi Jack (1) Remember that in the asset share formula you mention, the i is not referring to interest rates. For the asset share accumulation i is investment returns - this includes gains/losses due to changes in market values of assets held. The assets backing these without-profit policies are likely fixed-interest bonds. So, the argument is along the lines that a sharp increase in interest rates suggests higher bond yields & so falls in bond values. (2) If we consider pricing by equating the present value of benefits/expenses with present value of premiums, then using a higher interest rate in discounting would result in a lower premium. Intuitively, if future premiums are assumed to earn a higher return when invested, then the premium needed to cover the benefits/expenses will be lower. Hope these help! Lynn
