Interest on Negative Reserves

[Mbotha]

Hi

Mathematically, it makes sense that interest would be negative on negative reserves. I'm struggling to understand it from a bigger-picture point of view though.

Since negative reserves are an asset, why is there an interest CHARGE on it? To me, this implies that negative reserves are a loan of some sort on which interest is being charged but I don't understand why and what the "loan" would be for.

 

[Calum]

You have in a sense loaned money to the policyholder, because at this point in the policy lifecycle, the benefit is greater than the amount paid to date, and you are going to make it up in the future.

 

[Mbotha]

That doesn't make sense to me. Negative reserves mean expected premium income is greater than expected benefit and expense outgo, not the other way around.

 

[Lynn Birchall]

Hi

Does it help to think about the case of unit-linked policies. These could have:

• unit reserves of the value of the unit funds
• negative non-unit reserves

As you say, the negative non-unit reserves are possible because of the expectation that future charge income will exceed future benefit and expense outgo.

These future profits can be used to repay the "loan". In a sense these policies are lending money from elsewhere by holding reserves now that are smaller than the unit fund.

Lynn

 

[Calum]

That doesn't make sense to me. Negative reserves mean expected premium income is greater than expected benefit and expense outgo, not the other way around.

Sorry, I missed your reply somewhere.

The point is in a negative reserve situation, you have already paid out more in benefit than you've received in premium, and you expect to receive future premium to recoup this. So yes, *future* benefit outgo is smaller than future premium income. The 'loan' arises from the benefit you've already paid out.