RDR-Prudence

Just to check what would a decrease in RDR mean when you are valuing EV or liabilities..
I always thought a decrease in RDR would mean more prudence irrespective of whether you value EV or reserves.
The course notes seem to say that prudence would be different for these two metrics(EV,liabs) for a decrease to RDR!
Help

 

Hi Vikky

A few points:

1.Be careful: RDR is determined after considering such things as shareholder's required rates of return and is therefore appropriate to discount the future profits on a block of business (i.e. VIF). You would not discount reserves by RDR as it's not appropriate to do so but you would rather discount reserves using the valuation rate of interest (or the risk free interest rate curve). The crucial thing to appreciate with the VROI is that its determination is objective. [It's precise calculation is covered in SA2 and is not in scope in ST2 from memory]


2. Discounting future profits by a higher RDR is therefore 'prudent' as you lower the value of your VIF. [Remember the whole point of EV is to give shareholders a realistic assessment of the company's profitability].

3. Discounting reserves with a higher VROI or term structure of interest rates will reduce reserves and is therefore imprudent.

I suspect this should help explain the section of the notes you refer.

Hope this helps.

 

Cheers mugono..it makes sense now