Hi, In chapter 20, one of the features of the gross premium method is that:"reserves may initially be negative for non-linked business, partly due to initial expenses and partly due to capitalising the expected future profit". What does this sentence mean? I am confused as to whether this is referring to non-linked business or unit-linked business? Please help me with this query. Thanks. Lalitha.
Hi Lalitha, What I understand from this is .... For the Conventional Business ( called as Non Linked in the notes) the reserves may be negative during the early stages of the contract Which means - Value of future premiums are more than the value of benefits and expenses This could happen due to Initial expenses means- For Prospective reserve we are projecting future premiums and benefits only. There is a huge cash flow mismatch on day 1 , say for a monthly premium contract only one month premium is received but all the initial exp have been incurred Similarly, we capitalise the future profits in the reserve calculation even before they are earned Please let me know if this helped your understanding
Yes, Murali's comment below is correct, the notes are referring to non-linked business. A gross premium reserve is the expected present value of the benefits plus expenses less premiums. So it could be negative because premiums are high (as they contain a profit loading) or benefits/expenses are low (because we don't need to reserve for the high initial expenses at the start of the contract anymore). Best wishes Mark
Net Premium suited for CWP business! Not suited for CNP business though? Hi all Okay so say I want to compare the gross premium method and net premium method General Gross Premium Method: The method calculates an office premium using pricing assumptions(which explicitly allows for future expected expenses and future expected bonuses). The assumptions however are typically more best-estimate than prudent. The reserve would then be calculated using this office premium, but with supervisory assumptions(which would again be more prudent) for mortality, interest, expenses and bonuses - now we will see that the office premium is not big enough to support the liabilities&expenses under the contract - and hence NBS(new business strain) arises(although also partly due to high initial expenses - if initial expenses were equal to renewal expenses, the NBS would be entirely due to the difference in bases?) So the capitalised loss would be equal to the NBS in this case? Net Premium Method: The net premium is calculated using the supervisory assumptions(ie more prudent than the pricing assumptions) and does not take into account expenses and bonuses explicitly, although this can be done implicitly using a lower valuation discount rate. So to compare this with the gross premium method; the net premium will be (1)lower because of no explicit allowance for future expected expenses or bonuses, but then again will be (2)higher due to the supervisory assumptions being more prudent than the pricing assumptions. Point (1) can be offset if the valuation discount rate is suitably lowered, and this will make point (2) even more severe, leading to a higher net premium than office premium Since for with-profit business we want a smooth emergence of profit (because we want our profits to match our expected liability, in this case regular reversionary bonuses for additions to benefits method; even more so in fact for revalorisation, since there we typically distribute profit as they arise - only judgement here is in the k% that we distribute and whether insurance profit is also distributed to policyholders; guessing that the contribution method would be similar to the additions to benefit method in this case or does it depend on how the profit is distributed, ie cash, premium reduction or addition to benefit?) the net premium method would be better suited in that it does not capitalise the difference between the bases upfront. If this capitalised difference is a loss, this would mean that the reserving method is showing that the company is not holding enough reserves(and free assets would be used to fund the difference?) than if it were to use the net premium method? this would increase the cost of capital. So more or less I think(I hope!) I grasp why the net premium is more suited to with-profit business. I do however struggle with the net premium not being suited to net premium business - any help?? Sorry for the lengthy post, but I would really appreciate any help here!
