Net Assets

[Sayantani]

Hi,

In The Supervisory Reserves chapter we come across free capital(free assets) which is the excess of available capital over the required capital.
In EV calculation we come across net assets which is the excess of assets over reserves( a liability). Now how different is the concept of free assets from net assets or are they the same?

 

[Mark Willder]

Hi,

In The Supervisory Reserves chapter we come across free capital(free assets) which is the excess of available capital over the required capital.
In EV calculation we come across net assets which is the excess of assets over reserves( a liability). Now how different is the concept of free assets from net assets or are they the same?

Hi Sayantani

Different people will define these terms in different ways. However looking at the chapters that you quote they are slightly different.

We can think of the balance sheet as follows. The assets will equal the total liabilities. The liabilities are often broken down into three parts: the reserves, the required capital and the free capital. So free capital is the assets less the reserves less the required capital. This is the first situation that you have described.

For the purposes of SP2, the EV calculation ignores the required capital. So the net assets equal the assets less the reserves. If we allowed for required capital we could include it as part of the reserves or part of the net assets using the approach in SP2. The allowance for the required capital in the EV is covered in detail in Subject SA2, but for SP2 we can just ignore it.

Best wishes

Mark

 

[Sayantani]

Thanks Mark. It makes sense now.

 

[Sayantani]

Hi,
when we talk about embedded value we call the net assets as shareholder owned share of net assets.
why is this attributable only to shareholders(what happens to policyholders) and what happens in a with profits contract?

 

[Sayantani]

Hi,

I had another doubt related to the solution on embedded value in Monitoring Experience chapter.
Over there it is mentioned:
The PVFP component will increase at a rate lower than the risk discount rate .
I don't quite understand how that happens. Can this be explained with a numerical example?

 

[Mark Willder]

Hi,
when we talk about embedded value we call the net assets as shareholder owned share of net assets.
why is this attributable only to shareholders(what happens to policyholders) and what happens in a with profits contract?

Hi Sayantani

I think I've answered this in the other post you made, but let me know if that doesn't cover it.

Best wishes

Mark

 

[Mark Willder]

Hi,

I had another doubt related to the solution on embedded value in Monitoring Experience chapter.
Over there it is mentioned:
The PVFP component will increase at a rate lower than the risk discount rate .
I don't quite understand how that happens. Can this be explained with a numerical example?

Hi Sayantani

The solution on page 30 is saying that the PVFP will increase by less than the risk discount rate if experience is worse than expected.

We can see this with the following numerical example. Imagine that profits over the next three years are 12, 15 and 17. We calculate the PVFP as the present value of these profits using a risk discount rate of say 6%. So the PVFP is:

12/1.06 + 15/1.06^2 + 17/1.06^3

One year later these profits will be one year closer. Assuming that experience is exactly as expected and that we haven't changed our assumptions their value will be

12 + 15/1.06 + 17/1.06^2

So we can see that the PVFP has grown by a factor of 1.06 over the year, ie the PVFP grows by the RDR if experience is as expected.

Hence if experience is worse than expected the PVFP must grow at a rate slower than the RDR. For example if the expected profit of 12 turned out to be only 4, we would have a new PVFP of:

4 + 15/1.06 + 17/1.06^2.

Best wishes

Mark

 

[Sayantani]

Hi Mark,

Thanks for the above. It is clear now.