Question 23.3

[HelloWorld]

I am reading Chapter 23, and it is the case that in Question 23.3, is it possible that the free surplus reduction is greater than the PVIF increase because of the discounting effect of the release of reserves in the future to calculate PVIF ?

i.e. So the free surplus is at the present time and the same amount of reserve that reduces the free surplus is released in the VIF calculations. Thus due to the discounting reducing the value of the release of the same reserves that reduced the free surplus then EV falls ?

 

[mugono]

Hi

In the scenario described, releasing the reserves in the VIF will reduce EV overall if the return used to project the future profits in the VIF calculations is lower than the rdr.

If on the other hand the investment return exceeded the rdr then EV would rise overall.

Hope that helps.

 

[HelloWorld]

Is it that the investment return is based on the assets backing the reserves and premiums paid in and also the free surplus assets ?

Thanks

 

[mugono]

The investment return may be based on the assets backing the VIF (not reserves). Once the reserves are released they are no longer a reserve and will be freer to invest in a wider range of assets. (which is likely to have a higher return).

The investment return earned on the free surplus, required capital, premiums etc will be based on the assets that the insurer hypothecates against it.

Aside:
This ignores market consistent principles where all assets earn the risk free rate.