chapter 6 pg 18

[Sagar_sagar]

Answer to the question given on this page is not clear, please explain

 

[Mark Willder]

The latest version of the course doesn't have a question on this page. Perhaps you have an older version of the course?

Please can you give more detail about the question and why you find it difficult.

Best wishes

Mark

 

[Sagar_sagar]

question is
"explain why an MVR may be needed on unitised with profit contract but not on unit linked one"

 

[Mark Willder]

question is
"explain why an MVR may be needed on unitised with profit contract but not on unit linked one"

An example might help.

Consider a unit-linked fund with asset of 100. The value of the units will also be 100. So if all the policyholders surrendered then the insurer would have exactly the right amount to pay them in full.

If the assets fall in value by 50% then the unit price will be recalculated and so the new value of the units will be 50. Again, all the policyholders could surrender and the insurer would have exactly the right amount to pay them.

So with a unit-linked fund, any movement in asset prices is reflected by a corresponding change in unit values.

Now consider a unitised with-profits policy. Here the policyholder receives bonuses which are smoothed.

Let's say the assets are 100. The value of the units could be say 80 (with 20 left over for terminal bonus in the future). If everyone surrendered then the insurer would have enough money (100>80) and so there is no need for an MVR.

But now imagine a stock market crash of 50%. The assets are now 50, but the unit value is still 80 (bonuses are smoothed, but are not negative). So if everyone surrendered, then the insurer doesn't have enough money (50<80). So it needs to impose a MVR of 30 so that the assets of 50 equal the benefits of 80-30=50.

 

[Sagar_sagar]

but why and how such situation will arise?

i mean if UWP is unitised, then in case of surrender, unit value will be paid
how then in that case asset value could be different from unit value ?

please explain further

 

[Mark Willder]

but why and how such situation will arise?

i mean if UWP is unitised, then in case of surrender, unit value will be paid
how then in that case asset value could be different from unit value ?

please explain further

I think you are confusing unitised with unit-linked.

With a unit-linked contract the unit value is derived directly from the asset value. So if the assets rise/fall by 1%, the unit value will rise/fall by 1%.

Unitised with-profits doesn't work like that. The value of the units goes up with bonuses. These bonuses are smoothed. So if the assets go up by 15%, 5%, 8% and -20%, the bonuses might be 5%, 4%, 4%, 3%. If you plug these numbers into the calculator you will see that the unit value has increased by more than the assets. So this demonstrates the need for an MVR.

Best wishes

Mark