Hello, Can I double check my understanding of one aspect of reserving for conventional with-profits contracts? I understand from course material (and very useful posts on the forum) that we need to be careful if a gross premium reserve is used for WP policies because of the loadings for expected future bonuses in the GP. But if we used a prudent interest rate in the valuation basis, I understand this would no longer be an issue, at least in theory? For example, say we used 1% investment return in pricing, so if we expect to earn say 5%, the gross premium would be more than enough to cover for the guaranteed benefits and bonuses would be distributed. Then for reserves: if we used 1% valuation interest rate to calculate the gross premium reserve, then we'd be assuming that those office premiums, when invested, would grow only to the guaranteed benefit. So under this assumption it'd be OK to include the guaranteed benefits only (incl. bonuses to date) in the PV of benefits and deduct the PV of full office premiums, correct? The source of surplus in each year would be driven by actual returns in excess of the assumed 1% for valuation. the issue would arise if our valuation interest rate was higher than 1% used in pricing. For example, if it was linked to expected investment return, say 4%, that we'd deduct the PV of bonus loading in premiums at the outset and in future years we'd have little or no surplus to distribute, depending on actual returns Does this sound reasonable? Mateusz Thank you!
Hi Mateusz This is exactly right. In your first bullet you value the guarantees using a prudent set of assumptions so the future surpluses are expected to arise. This implicitly reserves for future bonuses. In your second bullet you value the guarantees using a realistic set of assumptions so no surpluses are expected to arise. So you have only reserved for the guarantees and have made no reserve for future bonuses. You could then have a separate reserve that explicitly covered the expected future bonuses. Best wishes Mark
