What happens to EV when we change 1)morality in reserving basis 2)mortality in realistic basis 3)Same for withdrawals and expenses and finally what happens when we change both together. Am having difficulty understanding this.. HELPPPPP
Hi Vikky Let's start with our EV being defined as made up of 2 component parts: (1) shareholder net assets (net assets = "assets - assets needed to cover liabilities") (2) PV of future shareholder profits from the existing in-force policies. Let's imagine we're talking about without-profits policies (as we usually are in ST2). Then our EV looks like: (1) assets - (statutory reserves + any capital requirement) (2) PV of future profits. We expect these future profits to happen because we've set reserves prudently, so if experience turns out as we expect (ie better than our prudent reserve assumption) we get profit. So, we can think about this profit as a result of the "gap" between our prudent reserving basis and what we really expect to happen. (1) Changing a reserving basis assumption It's a similar idea if we change any of the assumptions you mention. Let's imagine we make one of them more prudent, eg more prudent mortality assumption in the reserving basis, but keep everything else the same. Then: (1) more prudent reserving assumption results in bigger reserves and so smaller net assets. (2) expected future profits are higher (the gap between the reserving basis and what we really expect has got bigger). So, (1) goes down and (2) goes up. What happens to the EV overall? It depends on the relationship between the investment return we'd be able to earn on the assets vs the discount rate we use to discount the future profits. (2) Changing a realistic basis assumption Again, let's imagine we make one of them more prudent, eg more prudent mortality assumption in the realistic basis, but keep everything else the same. Then: (1) net assets don't change as we haven't changed the reserves (2) expected future profits are smaller (the gap between the reserving and realistic basis has got smaller). So, overall EV goes down. (3) Changing both bases together If we make both more prudent then: (1) net assets go down (as reserves are higher) (2) the change in future profits depends on how much we change the two bases by. If we change them so that the "gap" stays the same, then possibly the future profits stay the same. I hope this helps? It always seems to help with EV to consider the 2 component parts independently first, and then combine the 2 effects. Lynn
