CP1 - Chapter 26

[Darragh Kelly]

Hi,

Just have a couple of questions in relation to chapter 26

Page 12

To the extent that liquid funds are not set aside in advance of benefits being provided, the above factors will also lead to uncertainty about the incidence of contributions.

So if there are not liquid funds set aside we will be uncertain on how much and the rate of funds that can be set aside for benefits? Is this because we don’t know how or when we can sell the illiquid funds at a ‘good’ market value?

Page 13/14

Defined benefit promise with a defined contribution underpin. How exactly does this product work? If markets are doing well, then it becomes a DC because the underlying assets are doing well, and if markets perform poorly, it becomes a defined benefits scheme (ie when guarantee bits)?

Section 3.3 General contribution risks

On page 14, how does removal of tax status resulting from non-compliance with legislative requirements lead to uncertainty in contribution / prems required?

Section 4.2 Investment Risk

In the sol to the question on page 16, what does bullet point 3 mean ie reinvestment risk arising from mismatching assets and liabilities?

Section 5.5 Expense Risk

A product provider’s expense can be expressed in terms of a unit costs..

Just regarding the core paragraph under the solution to the question on page 20, struggling to grasp this concept specifically the expenses forming the numerator and volume measure as denominator.

Thanks,

Darragh

 

[James Nunn]

Hi Darragh

Some responses to your chapter 26 questions are as follows:

Page 12

If liquid funds are set aside, there will be money to meet benefit payments as they fall due and this advance funding will mean that spikes in benefit payments won't require spikes in contributions. However, if there are inadequate liquid funds set aside to meet benefit payments then additional (money) contributions may be needed to meet the shortfall, or shortfall in liquid assets. In the extreme, a pay-as-you-go funding method could be adopted, where there is no advance funding.

Page 13/14

Your understanding is correct. Which one (DB benefit promise or defined contribution underpin) bites will also depend on how valuable the defined benefit promise is expected to be relative to the value of the defined contribution underpin.

Section 3.3 General contribution risks

For example, pension schemes in particular have an advantageous tax status - there's tax relief on contributions. The risk is that, if this is withdrawn (possibly due to non-compliance with legislative requirements), contributions will need to increase and/or there will be less tax relief meaning lower profits or higher costs.

Section 4.2 Investment Risk

If you match your asset to your liabilities perfectly then income from the assets will be available at the right time and amount to meet outgo in respect of liabilities as it falls due. If you don't and your asset income is higher than needed in early years, you'll need to invest the excess asset income in future on unknown terms. The risk is that these terms may be bad in future - they are unknown - so that your profits (as a company) are lower as a result.

Section 5.5 Expense Risk

Insurers will often want to express expenses in terms of the expense per policy, per claim, or some other unit, in order to have a per-policy loading to cover these (eg an addition to premium or the annual fund management charge). These loadings have to be calculated in advance and may be fixed after a policy's inception. They will be based on the expected number of 'units' (ie the number we divide by to get the per unit expense).

Not all expenses are variable (ie depend on the number of units, whether that's the number of claims, the number of policies, or whatever 'unit' definition is chosen). This means that if there are less units in future (eg less policies are sold), the unit expense will higher than expected as, in the unit expense calculation, expenses on the top will not change by as big a proportion as the number of units on the bottom.