Internal sources of capital

[Gareth]

On flashcard 418 it suggests that an internal source of capital is "changing assets to influence the valuation interest rate used for the liabilities."

I really hope this isn't really suggesting that the actuary advising a distressed insurer could suggest that one solution is to move their assets into risky equities and then take advance credit for future outperformance by discounting the liabilities at a higher rate of interest?

That's the kind of thing you might end up on professional misconduct charges for...

 

[Anna Bishop]

Hi Ga reth

It's referring to a bit of Core Reading in Chapter 35 of the Course Notes, Page 8, where it says it is appropriate to take into account the assets in the valuation of the liabilities ...

... for the supervisory valuation of life insurance contracts, where legislation or regulation specifies a link between the liability valuation basis and features (usually the yield) of the backing assets.

You get a better explanation in Subject SA2. In the UK, for one of the valuations that is required, the regulators say that the valuation interest rate for the liabilities is:

97.5% of the risk-adjusted yield on the assets where:

for Gov bonds, the yield is the GRY
for corp bonds, the yield is the GRY adjusted down for credit risk
for equities, the yield is the dividend yield
for property, the yield is the rental yield

So different assets will result in higher or lower liability discount rates. If the GRY on Gov bonds is higher than the yield on other asset classes, it may be advantageous to switch into Gov bonds, as this will lead to a higher liability discount rate and hence a lower value of the liabilities.

Anna

 

[Gareth]

Ah excellent! I was seeing this in terms of how pension actuaries used to(?) think...