Profit v Return on Capital

[Sky02]

In a couple of solutions to past papers in the revision notes you have stated that profit may increase but return on capital may still fall (e.g. Q19 Bklt 5). I'd like to check if my reasoning for this is right or wrong, take above as e.g. -
No longer taking reinsurance:
Profits rise because no longer paying for reinsurance which was expensive due to reinsurers profit margins.
Return on capital falls because need to reserve more for possible future bad experience and don't receive this additional reserve back until product (in this case term assurance) has run off book.


Thank you

 

[rishanb]

hey i'm only a fellow student, tho i'm sure what have explained is correct

 

[Meldemon]

looks right to me too, maybe expand "future bad experience" to include higher expected value of claims paid out (no quota share arrangement in place) & more volatile claims payment experience (no stop-loss arrangement in place)...

 

[Lynn Birchall]

In a couple of solutions to past papers in the revision notes you have stated that profit may increase but return on capital may still fall (e.g. Q19 Bklt 5). I'd like to check if my reasoning for this is right or wrong, take above as e.g. -
No longer taking reinsurance:
Profits rise because no longer paying for reinsurance which was expensive due to reinsurers profit margins.
Return on capital falls because need to reserve more for possible future bad experience and don't receive this additional reserve back until product (in this case term assurance) has run off book.


Thank you

Sounds good to me too

I think there's also a related idea that if you're measuring return on capital by discounting back the future profits cashflows, then you might discount at a higher rate (and so get a lower value) as there's more risk.

Best of luck for the exam
Lynn