F102 (ST2) questions

[Goku]

I'm doing F102 which is the South African equivalent to ST2.

Have a few questions and will post them in this thread, hoping to get them answered by tutors (don't have access to tutors in South Africa).

Q1:
In Ch2 of the notes, for Q2.2, the (ActEd) solution mentions that there are 2 types of mortality risks for Whole of Life Assurance. The first type is making an overall loss from policies due to mortality i.e where death benefit exceeds the asset share.
Are ActEd referring to the combined asset share and comparing that to the combined death benefits of the company? Or is it in a policy level?

 

[Lynn Birchall]

Hi Goku

I hope the studying is going well so far

The notes are referring to a policy level here. Early in a policy's term, reserves are fairly low, so there is a big strain caused by a death.

Lynn

 

[Goku]

Alterations query - Unit-linked made paid-up

Question on Alterations, relating to Unit-Linked Contracts:

I'm writing F102 (South African equivalent of ST2).
My query is based on Ch28 (Alterations), Pg24, Section5, first paragraph.

Here is the extract of the core-reading, I require help on:
"When converting to paid-up status, the units attaching to the contract at the date of conversion will remain attached, possibly after deduction of any penalty that applies".

Thereafter a question follows, asking whether it's fair to apply a penalty (Question 28.17).
The solution provided by ActEd refer to only the recovery of unrecovered initial expenses from the original contract, when discussing whether the penalty is fair.


My question:
If the contract had a death benefit, why is the sum-assured not also reduced?
Or, should the sum-assured be kept the same, why is there no mention of the alteration penalty including allowances relating to the additional future losses relating to benefits in excess of the paid-up unit-fund?

The core-reading above mentions nothing about decreasing the sum-assured when converting to paid-up or keeping the sum-assured the same, and increasing the penalty charged on alteration.

I understand that charges will still be deducted from the unit-fund following the alteration, which are used to fund the benefits in excess of the unit-fund.
However, if these charges are guaranteed, say 2% p.a of the unit-fund, the likelihood of these charges being insufficient to meet the benefits in excess of the unit-fund is higher, as a result of the policy being made paid-up (i.e. no future premiums are paid).
The company should, therefore, try to recoup some of this loss by allowing for it in the penalty charged in the conversion to paid-up OR, if not, decrease the sum assured of the contract.
If charges are reviewable, the need to do the above (reduce sum-assured or charge a penalty) is decreased, albeit to the extent allowed for from PRE and the desire to offer competitive charges.

 

[Lynn Birchall]

Hi Goku

What you've written about the level of death benefit and future charge income sounds about right to me.

In practice, I suspect having benefit charges of the form "guaranteed 2% of unit fund" is unlikely, with it being more likely that these charges are a variable % of (death benefit - unit fund). With charges of this form, the smaller unit fund after a policy is paid-up will naturally lead to higher future deductions.

Lynn

 

[Goku]

Thanks Lynn.

Just queried it as the core reading made no mention of it. Least I know I could get a mark for it now

 

[Goku]

Original Terms Reinsurance - Level Risk Premium

1. Under the original terms reinsurance structure, for level risk premiums, please confirm my understanding set out below:

- Reinsurer provides the full risk premiums payable (based on 0% retention by the cedant)
- Cedant pays a proportion of the risk premiums to the reinsurer, as determined by the amount of risk reinsured
- Cedent then recovers a portion of the full sum-assured (i.e. not the sum-at-risk), based on the same portion used to determine how much of the full risk premium to pay.



2. For both normal original terms (where a portion of the office premium is paid to the reinsurer) and level risk premium, please confirm:

- whether the only cash-flows due to and receivable from the reinsurer (ignoring any profit-sharing), are reinsurance premiums and reinsurance recoveries respectively, or if not,
- investment income is shared with the reinsurer, due to the reserves of the reinsurer being retained by the cedent
- expenses are not shared with the reinsurer (they are allowed for in the commission paid by the reinsurer to the cedent)
- how the remainder of the income and outgo cashflow treated? e.g. tax invoices and receipts, once-off income and expenses etc.

The above queries are a result of the core reading mentioning that, under original terms reinsurance, all cashflows are shared with the reinsurer. So, just checking my understanding.

 

[Goku]

Tutors? Response please?

Awaiting response...

 

[Lynn Birchall]

Hi

I'm sorry for taking a few days to reply to your post

For 1, yes your understanding seems fine to me.

(In case anyone is reading this thread while studying for 2015 exams or later, note that the Core Reading here has changed and this reinsurance type is now called "level risk premium reinsurance".)

For 2, I'd say it's just premiums and benefits that are shared. There may also be reinsurance commissions (from reinsurer to insurer). The other cashflows (eg tax) are determined for each company separately.

Hope this helps
Lynn

 

[Goku]

Risk Premium reinsurance queries

Good day

In The QA bank (Q5.17, the solution to part (iii) c) mentions that when using risk premium reinsurance, it's cheaper to base it on sum-at-risk rather than full sum assured as the reserves are not at risk.

I understand the above but have a few follow-up questions from that:

1. Is the above explanation referring to the reinsurer's reserve? Or the direct writer's?

2. When using risk premium, on sum-at-risk basis, does it mean that the direct writer's reserves remain unaffected?
In other words, does the direct gain only by making lower mortality losses?
And does this therefore make risk premium, on sum-at-risk, quite ineffective in reducing new business strain (as a result of the direct writer's reserves not being affected).

3. Under level risk premium reinsurance, does the benefit, in comparison to original terms, come about mainly by the direct writer paying lower reinsurance premiums (as the reinsurer's basis will not include as large margins as that in the direct writer's office premium).
Under level risk premium reinsurance, can the direct writer hold lower reserves (as a result of sharing the full sum assured with the reinsurer)?

4. (Apologies if this question seems silly).
Given that the direct writer's reserve is not at risk, why is there a need for original terms? Using risk premium, on sum-at-risk basis, makes the greatest sense and will become cheaper as the reserves increase.

Hoping to get answers to these by this weekend.

Thanks.

 

[Lynn Birchall]

Hi Goku

Taking these in order...

1. Direct writer's reserves

2. I think the reserves would still reduce

3. Another advantage is that the link between the premiums the direct writer charges customers and the premiums it pays its reinsurer is broken. So, for example, this might make it more able to change its premium rates for competitive reasons.

4. It's not a silly question Original terms might be used, for example, for a conventional without-profits protection contract. Here, reserves might be small throughout, and OT would be easier administratively. Other factors may also come in to play, eg risk premium reinsurance might be arranged annually whereas OT might offer longer term cover.

Best wishes
Lynn

 

[Goku]

Thanks for the replies Lynn. I'll dwell a bit on some of those answers.

There was a moment in the weekend when level risk premium and normal risk premium reinsurance made perfect sense (I knew how it affected reserves, premiums and outgo).
Hoping to get back to that space soon.

 

[Goku]

Unit-linked Pension Product: principal risks

When discussing the principal risks of a unit-linked pension product, ActEd's solution to an assignment question I've attempted mentioned that the contract will have insignificant mortality risk as it is primarily a savings product and offers very little protection benefits. (Assignment 2, Q2.6).
The only mortality risk it mentioned would be that from a guaranteed annuity rate, if it was offered (which I understand as the unit fund proceeds may be too low to fund the guaranteed annuity and so humbly accep that I missed that point).


But, what about pre-retirement high mortality risks stemming from:
- death benefits, if offered (unit fund being lower than death benefit)
- dying early in the term where asset share is negative.

And what about post-retirement low mortality risks related to purchasing the annuity? (longevity risks)?

 

[Lynn Birchall]

Hi Goku

I suspect the pre-retirement mortality risks didn't make it into the solution because the questions asks for the principal risks. I agree that the two elements of risk you mention do potentially exist, but given the savings focus of the product it is unlikely that the death benefits are significantly in excess of the unit fund. So probably not one of the major risks?

The post-retirement longevity risk is outside the scope of the product. The unit-linked contract will be just the pre-retirement savings vehicle.

Hope the studying is progressing well
Lynn

 

[Goku]

NAV query

Thanks for the response Lynn. Makes sense now.
Studying is ok, struggling with some sections though (supervisory reserves, alterations).

Came across an assignment question that asked to differentiate between NAV and EV.

ActEd Solution mentioned that for NAV, "future profits are effectively discounted at the expected future rate of return on net assets".

Does this mean it includes future releases in profit which, for example, could come from zeroizing negative reserves (in other words, where negative reserves are not allowed). Or, more generally, where future surpluses arise from the premium basis being higher than thevaluation basis?

I understand that the NAV will just be the value of retained profit and assets less the value of the liabilities. Therefore present value of future profits (PVFP) will not reflect in NAV but instead EV (specifically speaking, only the portion distributable to shareholder).

Look forward to your response.

 

[Goku]

Best estimate reserves

Hi Lynn

In the chapter "Setting Assumptions (2)", section 1.2 (Best Estimate Reserves), the core reading states:
"Here assumptions will be produced which are stripped of margins. The basis derived will be closer to that used for new business pricing, though without the effect ofunderwriting."

I understand and agree with all of this except where it mentions that the basis derived will be closer to pricing.
To my understanding thus far, the pricing basis contain margins for risk factors.
So, how can we use a basis similar to the pricing basis for best estimate reserves?
Surely the assumptions in the latter basis would need to be free of margins?

 

[Muppet]

I think everyone is probably right here - more than one way to price! But generally speaking, your margins in a pricing basis can't be too big or premiums would be too big and uncompetitive. Hence pricing basis won't be too far away from best estimate. But also you might keep your risk margins outside of the assumptions, eg by using a high risk discount rate, or targeting a higher explicit profit.

 

[Lynn Birchall]

Hi

Thanks Muppet - sounds good to me

ActEd Solution mentioned that for NAV, "future profits are effectively discounted at the expected future rate of return on net assets".

Does this mean it includes future releases in profit which, for example, could come from zeroizing negative reserves (in other words, where negative reserves are not allowed). Or, more generally, where future surpluses arise from the premium basis being higher than thevaluation basis?

Not quite. The realistic net asset value is just the best estimate value of assets - best estimate liabilities. It doesn't actually allow for the valuation basis / the need to set up prudent reserves. Chapter 19 Section 2.4 discusses this point a little I think. Maybe the numerical example there helps?

PS If it's any consolation, I think most people struggle with the supervisory reserves and alterations!

Lynn