Q 2.8 of Q&A bank has a unit linked product with less than 100% allocation, 5% b/o spread, 1.2% amc and a surrender value of bvu - 7% of prems due up to the 8th anniversary.( 10 yr term) It says discuss when the duration of the negative sterling reserves might be supported? The answer says during first 8 years at most when SP applies. Could you explain this a bit more? However, I thought that if we have a surrender penalty and the policy is actuarially funded(it may not be in this question) then there is a positive sterling reserve required to buy back the units to bring it up to the full value of the fund. This reserve would be unwound as the units are bought back???
I'm a little bit confused by what you mean in your last paragraph, if I ignore for now and explain the need for the SP.... Think of it in terms of the requirement that the total reserve (unit reserve plus sterling reserve) must be at least as high as the gteed surrender value. If you have no surrender penalty, this implies that on surrender, policyholder will simply get the bid value of their unit fund - i.e the unit reserve. If sterling reserves were negative, the total reserve would be less than surrender value because total reserves is [ Unit reserves + negative number < unit reserves]. Therefore a surrender penalty is needed to support negative sterling reserves.
I might be wrong, but I don't think you would ever have both actuarial funding and negative sterling reserves on the same policy, since they are both trying to achieve the same aim of reducing the initial capital requirements. So yes, the point you make is correct. If there is actuarial funding (which we need a surrender penalty to use) then we would end up with a positive sterling reserve.
No, I'm afraid this is not right. The purpose of actuarial funding is to reduce the reserves required at outset and hence offset some of the new business strain. If you reduced the unit reserve, but held a larger non-unit reserve, then this wouldn't help the new business strain. But you are right that we do need to buy back the missing units. We do this by using the high fund management charge in future years to gradually buy back the missing units. A problem occurs here if the policyholder surrenders as now the future charges will not be paid. So instead we impose a surrender penalty that is at least as large as the future charges would have been. Best wishes Mark
