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Projected cost of guarantee - Chapt 16

M

MindFull

Ton up Member
Hey All,

I had two questions about the solution for 16.4.
1) Why would cases that show a reduced NPV (with all the new cfs) be undercharging for the guarantee? I would think profitability would be decreased with the guarantee.
2) Why is the projected cost of the guarantee a function of the fund size? Is it because the fund size will dictate the annuity amount based on the conversion factor, and the larger the annuity, maybe the larger the cost or providing it?

Thanks.
 
JamaicanJem said:
Hey All,

I had two questions about the solution for 16.4.
1) Why would cases that show a reduced NPV (with all the new cfs) be undercharging for the guarantee? I would think profitability would be decreased with the guarantee.
2) Why is the projected cost of the guarantee a function of the fund size? Is it because the fund size will dictate the annuity amount based on the conversion factor, and the larger the annuity, maybe the larger the cost or providing it?

Thanks.
Click to expand...
Hi JamaicanJem

I’m surprised nobody has answered this. I don’t have the notes but will give it a go :).

1. There (should) be a cost for providing a guarantee. The insurer can only be worse off for having provided the guarantee compared to not providing the guarantee at all. If the NPV that includes the guarantee lowers the NPV (compared to the ‘no guarantee’ NPV) then this would lower the profitability of the product. The guarantee charge would need to be increased to preserve profit margins.

2. Sounds logical to me :)
 
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