Negative liabilities

Discussion in 'SP2' started by Joseph Barnett, Sep 17, 2019.

  1. Joseph Barnett

    Joseph Barnett Member

    Hi,

    As I'm doing more questions leading up to the exam I'm noticing that I'm really not that confident with how a life insurer's balance sheet is put together, and I'm blagging my way through a lot of questions where that's important background knowledge.

    I'm probably confused about a lot of things but for the sake of asking one straightforward question, I think I'm mostly hung up on the concept of a negative liability vs. a positive asset. It's mostly embedded value questions that are making me sweat but I think it probably applies to any question where I really have to think about what would happen to the balance sheet. To keep things simple I'll just restrict my question to a market consistent embedded value calculation.

    I'm always tempted to treat premiums and charges as assets and benefits and expenses as liabilities, but on reflection I think this is all liabilities. I think what's always stopped me from making that jump is that if a contract is purely profitable it will just look like a negative liability, which takes some getting used to.

    Now... for embedded value we have the two components - net shareholder assets plus present value of future profits. If a unit-linked policyholder decided to throw in a big premium, what I think would happen is:
    1. The company creates a bunch of units for the policyholder, which sit on the liability side
    2. The company buys a bunch of assets to back the units, which sit on the asset side
    3. The company expects (hopefully) more from the contract due to a higher fund value (from % charges), and this sits on the liability side as a negative figure
    So if I'm right about that, then a big single premium of X is added to a unit-linked policy will increase the assets by X, and the BEL by slightly less than X. And therefore, if we're talking about EV, I guess this would mainly hit the net asset component rather than the PVFP component. Is that right? My poor brain really wants to have a nice simple picture where premiums and charges mean profit and profit means increase in assets, but I think at this point in my actuarial career I should maybe just get used to the idea that insurance profits mostly come from under-performing liabilities...I never would have guessed that accounting would be the hardest part of being an actuary! :confused:

    I'd appreciate if someone could have a look through my explanation and tell me if I'm getting it or if I'm just talking nonsense.

    Thanks,
    Joe
     
    Joseph Barnett, Sep 17, 2019
    #1
  2. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Hi Joe

    I think you have this spot on. :)

    Reserves are the expected present value of Premiums/Charges less Claims less Expenses. So yes, premiums and charges are considered on the liability side of the balance sheet and have the opposite sign to the claims and expenses.

    We'd hope that the premium/charges would exceed the claims and expenses on a best estimate basis over the life of the contract, so we'd make a profit. So yes, we'd get a negative reserve at outset on a market-consistent basis for a regular premium policy at outset.

    So yes you're right about your unit-linked contract. The assets go up by the premium (less some expenses). The unit reserve goes up by the premium (less some initial charges) - these probably largely cancel out. The non-unit reserve should gives a negative impact because we expect to make profits out of future charges on a market-consistent (best estimate) basis.

    Best wishes

    Mark
     
    Mark Willder, Sep 18, 2019
    #2

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