Why do we charge interest on the initial expenses? Is it standard practice with reserves to assume that all expenses are paid at the end of the policy year, and all expenses incur interest?
Hi Danny, I can't see a question 16 on the paper you've identified. However, i'm guessing that you might be thinking about this in the context of profit testing? For profit testing we work out for each policy year the profit/loss at the end of the year given that the policy is in force at the start of each year. Hence, we need all values to be end-year values so any cashflows incurred at the start of each year eg premium, expenses, start-year reserve need to be rolled up with interest. If this is not answering your question at all then please come back to me If the question itself is important then double check the reference Joe
Ah ok. In that case we're not applying interest per se, we're inflating the expenses. But if expenses are going up at 1.92308% and we're discounting back at 6% this is equivalent to treating the expenses as level but discounting back at 4%. We use this same logic for compound increasing benefits (albeit we sometimes need to do some factorisation first). Joe
Hi Joe, I don't think you are referring to the question I had in mind - CT5 September 2013, question 13 is does nor mention inflation or any particular interest rate. Perhaps you're looking at April 2013? Sorry, I really messed up the title of this thead. Essentially, the question is a recursive relationship between reserves type of question, if that helps to identify it! Thanks,
That's ok. The principle is the same. We take cashflows or values at the start of the year, grow them with interest over the year and set them equal to the expected value of the cashflows we need to pay out at the end of the year. We use this same formula for profit testing but it appears slightly different in the way we set it out. As a quick example, if a company receives a premium of 1,000 at the start of the year but has to pay expenses of 200. Then the net cashflow is 800 and the company can invest that over the year to earn interest so it will grow to 800*(1+i) at the end of the year. This money can be used to cover any expected death benefits, claim expenses or the expected cost of setting up reserve required at the end of the year. Joe
