Further to the thread above, please confirm my understanding that when a company holds positive non-unit reserves, a reduction in lapse assumption will increase PVIF due to:
i. charges being greater than expenses will now be received for a longer duration for those policies which previously were assumed to have lapsed.
ii. reserves being zeroised, the benefit of reduction in reserves is not fully absorbed.
I think you have misread the solution to September 2013 Q1 (iii). The Examiners Report says that the the majority of non-unit reserves are negative, with few cases of positive non-unit reserves.
So when a company holds negative non-unit reserves (rather than the positive reserves you mention above), a reduction in lapse assumption will increase PVIF due to charges being greater than expenses.
If charges are bigger than expenses then we have no need to hold a reserve (and indeed we can even hold a negative reserve representing the future profits we expect to make). A reduction in lapses means that more policies continue in force and we receive more of these excess charges.
If a company holds positive non-unit reserves for a “minority” of small policies, how come will there be a resulting “material” increase in PVIF? ?
We would get the opposite effect to that I described above for policies with positive non-unit reserves (ie a decrease in PVIF). But as there are few policies in this category we can largely ignore them and focus on the large number of policies with negative non-unit reserves.
Also this does not seem to tie up with the last paragraph, which states that the high PVIF change suggests that negative non-unit reserves are NOT held. Can anyone please clarify?
A good approach with any exam question is to break it down into its component parts. As we are looking at EV we have assets less reserves plus PVIF.
The Examiners Report has started by discussing the impact of the basis changes on the reserves and has tried to draw some conclusions based on this alone. This is the discussion I have refererred to in my earlier comments (where we felt that there may be significant negative non-unit reserves).
The Examiners Report then moves on to look at the impact of the basis changes on the PVIF. We now draw the conclusion that perhaps any negative non-unit reserves have been zeroised, but we cannot be sure as the numbers we are given are at a very high level.
Often we will have factors pulling in opposite directions and cannot be certain which one will win. In the exam its best to describe all these factors as they could all score marks. In practice we would need to do more analysis to conclude which of the possibilities we suggested was correct.
Part ii of September 2013 Question 1 – Operating Assumptions
The “experience assumptions” referred to in the fourth paragraph under the heading “Operating Assumptions” on pg 4 of the Examiners’ Report are those used for the realistic evaluation of the EV projection basis. Please confirm? Would it be safe to say that these should be the same as the expected experience assumptions in the Experience Variance?
Operating assumptions refer to both the EV projection basis and the reserving assumptions. So we have two sets of assumptions for each of mortality, expenses etc.
The experience variance would also look at these same assumptions (mortality, expenses etc) to analyse the difference between actual and projected experience.
Is my line of thought correct that when the reserving basis is strengthened, this results in: a higher release in this year’s profits of 0.3m and [ii] higher future profits till run off – reflected in a higher PVIF?
I think you have this the wrong way round.
The Examiners Report suggested that the valuation basis has weakened. This would reduce the reserves and so lead to the extra 0.3m of net assets.
The report also suggests that changes to the experience basis assumptions have been made to reflect expectations of better future experience, ie the EV projection basis has been weakened so that we now expect more future profits and PVIF goes up by 5.0m.
This was a very tricky exam question, but I hope this helps to clarify the solution.
Best wishes
Mark