Hi Lindsay, In calculating cost of residual non hedgeable risk for MCEV using cost of capital method for with profits business, is the loss absorbance capacity of technical provisions considered in SCR? Can you please share the reasons for yes or no? And if yes, what are it's implications on EV for with profits business as it is primarily present value of future share holder transfer which in turn depends on the Policy holder bonuses on which the loss absorbing capacity depends? I am sorry I am asking this post exams but I am still confused on this. Thank you.
The allowance for the cost of non-hedgeable risk is, broadly speaking, an approximate allowance for uncertainty in the best estimate of shareholder cashflows as a result of the non-hedgeable risks, including allowance for risks that have not otherwise been reflected in the assessment, eg operational risks. For WP business, the PV of shareholder profits is, as you say, the shareholder transfers generated by future bonuses. If bonuses are reduced as a result of non-hedgeable risk events (eg expenses higher than best estimate), then shareholder transfers will also be reduced. This could be assessed, for example, by applying a prudential margin to the relevant assumptions. The PVFP (present value of future shareholder transfers) would be correspondingly lower, to allow for the possibility of mis-estimating these assumptions. Alternatively, if you want to use the cost of capital method as a proxy for the cost of non-hedgeable risk, you could take the stressed value of future bonuses under each event, eg higher expenses - bearing in mind that the value of future bonuses would be reduced under such a stress. Assuming a 90:10 fund, 1/9 of that reduction would be applicable to the present value of shareholder transfers (since s/h transfer = 1/9 cost of bonus). You would then need to apply whatever "cost" parameter you have chosen, allow for the run-off and discounting etc. Does that help?
