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Prospective reserve (future bonus)

J

jimlad

Member
What is a prospective (future bonus) reserve?

How does it work?

Retrospective is basically an asset calculation, no? That's simples enough. I just don't get what future bonuses has to do with a current liability figure?
 
Hi

I'm assuming you're talking about these in relation to doing the with-profits benefit reserve in a Peak 2 valuation of with-profits business?

Yes, a retrospective method is basically an asset share.

If a prospective method is being used (eg because an asset share method is not appropriate for some reason), then the method is still trying to allow for a realistic measure of a company's liabilties in respect of the with-profits policies. These liabilitites include future bonuses and therefore a realistic allowance for bonuses is made in the calculation.

Hope this helps
Lynn
 
Thanks for the fast reply Lynn.

Asset share allows for the built up value of the policy, that makes a lot of sense.

Prospective reserve... how does it allow for bonuses already declared? I don't really understand how/why the two are equivalent.
 
Hi

A prospective reserve formula for a conventional with-profits policy could look like:

Value (Sum assured + Bonsuses declared to date) + Value (future expenses) + Value (future bonuses) - Value (future premiums).

So, the bonuses already declared are treated like the sum assured (as these are both guaranteed benefits). The future bonuses assumptions will need to be in line with TCF. To set these assumptions, the company might project asset shares.

In a simple case, the prospective reserve is then rather like projecting asset shares and then discounting them back (ie asset shares are projected, they're turned into bonus rates that determine future benefits as being set by asset share, and these benefits are then discounted back). That's why the retrospective and prospective approaches are equivalent.

(In practice, likely to actually use a cashflow approach rather than a formula, but doesn't change the logic).

Not sure if this is quite answering your question? ;) Hope so, but do say if anything's not clear :)

Lynn
 
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