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Net Premium Valuation

J

jimmytee

Member
Hi,

Anyone kind to explain why " Net premium valuation is particularly suitable for Conventional With Profits busziness, as it does not result in the capitalisation of future profit margins in gross premiums"

When you say capitalising, what does it mean? Taking the future profit and using it now?

Any specific numerical example to illustrate this?

Thanks a lot. Need help badly.
 
Hi

Need to keep in mind here that for with-profits business the actual (gross) premiums being paid are far higher than what's expected to be needed to meet benefits and expenses. These margins in the premium should be paid out as future bonuses.

A gross premium valuation:

Value of benefits (sum assured + bonuses declared to date)
+ Value of expenses
- Value of gross premiums

(1) capitalises these margins (ie turns them into a value now). As the premiums are expected to be more than enough to cover "benefits + expenses" this value will be negative (ie they are an asset rather than a liability). So, it takes the future profit now as you say

(2) doesn't do anything with it. Which is the problem really. It wouldn't be too bad if the gross premium valuation formula also allowed for the value of future bonuses. So, if we're using a gross premium valuation method for with-profits business, we should include a prudent allowance for future bonuses in our formula.

This issue doesn't arise with a net premium valuation method as the net premium is worked out on the same assumptions as those used to value the benefits (and so isn't "too much" to cover the cost of the benefits).

Hope that helps
Cheers
Lynn
 
Lynn Birchall said:
Hi

Need to keep in mind here that for with-profits business the actual (gross) premiums being paid are far higher than what's expected to be needed to meet benefits and expenses. These margins in the premium should be paid out as future bonuses.

A gross premium valuation:

Value of benefits (sum assured + bonuses declared to date)
+ Value of expenses
- Value of gross premiums

(1) capitalises these margins (ie turns them into a value now). As the premiums are expected to be more than enough to cover "benefits + expenses" this value will be negative (ie they are an asset rather than a liability). So, it takes the future profit now as you say

(2) doesn't do anything with it. Which is the problem really. It wouldn't be too bad if the gross premium valuation formula also allowed for the value of future bonuses. So, if we're using a gross premium valuation method for with-profits business, we should include a prudent allowance for future bonuses in our formula.

This issue doesn't arise with a net premium valuation method as the net premium is worked out on the same assumptions as those used to value the benefits (and so isn't "too much" to cover the cost of the benefits).

Hope that helps
Cheers
Lynn
Click to expand...

Hi Lynn, Thanks for the explanation.

What do (1) and (2) mean here?
 
Dear Lynn,

I have a few thoughts/questions. please see below -

Lynn Birchall said:
Hi

Need to keep in mind here that for with-profits business the actual (gross) premiums being paid are far higher than what's expected to be needed to meet benefits and expenses. These margins in the premium should be paid out as future bonuses.

A gross premium valuation:

Value of benefits (sum assured + bonuses declared to date)
+ Value of expenses
- Value of gross premiums

(1) capitalises these margins (ie turns them into a value now). As the premiums are expected to be more than enough to cover "benefits + expenses" this value will be negative (ie they are an asset rather than a liability). So, it takes the future profit now as you say

I think it depends on how the future bonuses have been allowed for in the premium basis. If they are just allowed by taking the margins in assumptions (such as mortality, expenses) for the future and we are using exactly the same assumptions (mortality, expenses) in GPV, then I dont think we still will capitalise the future bonuses. ??

- However if there was an explicit assumption about the future bonuses in the premium basis and realistic assumptions about the other elements (e.g. mortality) and then if we are are not EXPLICITLY allowing for the future bonuses and still using the same(premium basis) assumptions in GPV then we are actually capitalising the future bonuns.

(2) doesn't do anything with it. Which is the problem really What is the problem in this? Do you mean it is same as the 1st point?. It wouldn't be too bad if the gross premium valuation formula also allowed for the value of future bonuses. So, if we're using a gross premium valuation method for with-profits business, we should include a prudent allowance for future bonuses in our formula.

This issue doesn't arise with a net premium valuation method as the net premium is worked out on the same assumptions as those used to value the benefits (and so isn't "too much" to cover the cost of the benefits).

Hope that helps
Cheers
Lynn
Click to expand...
 
Hi
I think the logic in your two new (blue) paragraphs are spot on. The possible problem with the first example (where you have the same reserving and premium basis) is what happens when you want to change the reserving basis? You can't change the premium basis retrospectively so any change in reserving basis will cause capitalisation of profit (or loss, depending on which way the basis changes - and of course capitalising a loss is prudent so that's OK!)

But then what happens if you want to change the premium basis for new business - eg you want to load your premiums in such a way going forward that different rates of bonus will be earned in future (this is something that with-profits offices at least used to do!)? Then if you used the same-basis valuation approach you would need different valuation bases for different policy entry years, and this then gets very messy, and rather hard to justify to the regulator.

The joy (!) of the net premium valuation is that the premium valued changes with the valuation basis, so in effect you do have exactly what you stated in your first paragraph - valuing a premium that is calculated on exactly the same mortality and interest assumptions as your reserving basis. And then you can change the reserving basis if you need to for other reasons without risking any capitalisation of future profits.

I've woffled on a bit there - does any of that make sense?
 
Hi Robert,

Thanks for your reply.

Yes, your points make a perfect sense.

I found your point in second para quite interesting which says about the inflexibility of the GPV method in terms of changing basis . Changing the basis for reserving, in practical terms might be a necessity as the company secures new business or the Regulator prescribes some new assumptions to be used.

Cheers :)






Robert Chadburn said:
Hi
I think the logic in your two new (blue) paragraphs are spot on. The possible problem with the first example (where you have the same reserving and premium basis) is what happens when you want to change the reserving basis? You can't change the premium basis retrospectively so any change in reserving basis will cause capitalisation of profit (or loss, depending on which way the basis changes - and of course capitalising a loss is prudent so that's OK!)

But then what happens if you want to change the premium basis for new business - eg you want to load your premiums in such a way going forward that different rates of bonus will be earned in future (this is something that with-profits offices at least used to do!)? Then if you used the same-basis valuation approach you would need different valuation bases for different policy entry years, and this then gets very messy, and rather hard to justify to the regulator.

The joy (!) of the net premium valuation is that the premium valued changes with the valuation basis, so in effect you do have exactly what you stated in your first paragraph - valuing a premium that is calculated on exactly the same mortality and interest assumptions as your reserving basis. And then you can change the reserving basis if you need to for other reasons without risking any capitalisation of future profits.

I've woffled on a bit there - does any of that make sense?
Click to expand...
 
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