Lots of September 2005 Questions

1. The solution says:


The capital requirements will differ for different products. If a higher proportion of capital intensive products are sold than expected then this may lead to solvency problems. Please explain what would make a product to be more capital intensive than other products. Will solvency issues arise because of a higher reserve being held for capital intensive products?

 

4. The solution says:


1)The payments are for guaranteed amounts, and hence the yields should be “risk-free”? Please clarify.

2)The yield on these bonds can therefore be used as a proxy for “risk-free” yields although it might be necessary to make adjustments if there are specific market issues such as supply and demand mismatches. Please clarify.

3) The expected expense cash flows might be valued by discounting at the yields available on index-linked government bonds (*). Why?

4) Although the expense cash flows could include inflation and these would then be discounted at the normal risk free yield. How is this similar to (*)?

 

5. The solution says..
a) Since the company will invest a significant proportion of assets in equities, which have a volatile return, the underlying asset share is likely to be volatile. This is particularly true for a single premium policy. Why is it so for a single premium?

b) It is normal for reversionary bonus to form part of the supervisory reserves, but for no reserve to be held for Terminal Bonus. This means that a higher proportion of reversionary bonus will increase the statutory reserves that the company needs to hold. These reserves are unlikely to be sensitive to changes in the market value of the assets held. Please explain why reserves are unlikely to be sensitive to changes in the market value of the assets held.

c) Shareholders may prefer bonus to be paid sooner. Why?

d) Shareholders may be willing to inject more capital into the company to allow higher reversionary bonuses as long as the return generated on this capital for these shareholders is high enough. Is this via higher dividends and higher share prices in the future?

e) The company would need to consider what access it has to alternative sources of capital which may mitigate the risk of having to draw down further capital from shareholders. What risks are they referring to?

 

6. The solution says:
Please clarify these points.

1)The method of calculation should be such as to recognise profit in an appropriate way over the duration of policy?

2) It should not be subject to discontinuities arising from arbitrary changes in basis?

3) Reserves calculated should also be set to avoid future valuation strain?

 

6. Unit growth rate

a) Needs to be set prudently? How will this be done?

b) If assets earn 10% say, will unit growth rate earn say 7%. This will be given via unit prices e.g. 110, 120, if assets grow by 110, unit fund will grow by 103 say?

 

7 1)Expenses of the company can be split into “cells”. Whole business of a particular accounting fund? I don't understand accounting fund?

Finance Director’s Suggestions

a) Business mix may have changed, thus overheads need to be split in a different way?

b) Analysis of surplus and profit may not be valid if expense assumptions do not closely reflect actual expenses?

c) Performing a more accurate expense analysis may allow reserves to be released?

d) These may have been caused by past margins in expense or inflation assumptions which were deemed necessary due to lack of confidence in the data?

 

1. (a) this is explained early on in the ActEd notes but things like premium frequency, initial expenses, product design (eg any guarantees, NP or WP or UL) etc. (b) yes

4.1 If you can get a guaranteed amount n the future then it should give you a risk-free yield. Alternative ans: we tend to start with risk-free in a market consistent valuation.
4.2 the yields on the gilts might not be considered risk-free, so we adjust them
4.3&4 I think it's saying either take the real expenses (ie current values) and discount at the real rate, or project forward the expenses allowing for inflation and discount at the money rate.

5a all invested at the same time
b: think we've touched on this elsewhere - probably a bit out of date now
c: sooner profits / dividends
d: yes:
e: of having to draw down further capital from shareholders (s/h don't like being asked for money too often, if at all.

 

6, (1,2,3) last year's course

 

6a best estimate less a margin
b. don't follow

 

7.1 just think of it as a subset of a business with similar type of policies in it - eg all with-profits
a-d : don't see what you are actually asking. Suggest you try being more specific.

 

Thank you.