Release of reserves/Analysis of Profits

[razen]

Hi Everyone

Quick question - Should a change in statutory/reserving assumptions be considered as a source of profit when analysing the release of reserves which is what gives a profit (or loss) under EV?

In EV, the profits are effectively the release of the statutory margins and any change in the statutory basis should merely change the timing that the profits are recognised but not the total amount of profits generated.

However I'm struggling to understand the above paragraph because, there is a slight change in profits when the statutory basis is changed and this very small difference could be significant if the fund is very large - therefore a change in statutory basis does change the amount of profits and therefore should be included as an item when performing analysis of profits, right? Have I mis-understood something?

Please help, thank you!

 

[Lynn Birchall]

Hi razen

Yes, a change in statutory reserving assumptions should be considered as a source of change in EV.

In EV, the profits are effectively the release of the statutory margins and any change in the statutory basis should merely change the timing that the profits are recognised but not the total amount of profits generated.

Yes, I agree with this. However, we need to note that although the total amount of profits is unchanged, by changing the timing we may be changing the value of the profits.

I'm afraid I don't see what you're asking in the final paragraph of your post
If anything's still not clear, could you post again & I'll try again!


Best wishes
Lynn

 

[razen]

Thanks a lot Lynn!

I think what I was trying to say in my last paragraph was that the total amount of profits would change when there is a change in the statutory basis. Maybe a simple example might help me explain my query better

For eg, if we have a 1 year contract with reserves 100 (assume statutory claims estimate of 102 discounted back at valuation interest rate of 2%) and expected claim at end of the year on EV basis is 90. If the EV projection rate is 5%, then the reserves at the start will grow to 105. Profit at the end of the year is then 105 - 90 = 15. If the risk discount rate is 9%, then the VIF would be 15/1.09 = 13.761. If insurer had assets of 150, then the EV is 150 - 100 + 13.761 = 63.761 (ie EV = Total Assets - Reserves at start of year + VIF)

Now, if the valuation interest rate were to increase to 4%, then:
Reserve at start of year = 102/1.04 = 98.077
Reserve at start will grow at 5% to be: 98.077 * 1.05 = 102.981
Profit at the end of the year will be = 102.981 - 90 = 12.981
VIF would then be = 12.981/1.09 = 11.909
and EV would then be = 150 - 98.077 + 11.909 = 63.832

So the EV has changed by a very slight amount from 63.761 to 63.832 when the valuation interest rate changed. If the fund was very large, then this change in EV would be significant. Therefore, a change in statutory basis (in this example the valuation interest rate is changing from 2% to 4%) would change the total amount of profits, right?

I guess what I'm struggling to understand is how does the total amount of profit remain unchanged when the statutory basis changes, when the simplified example above seems to suggest otherwise. Have I confused profits, VIF and EV? But all three items also seem to have changed in amounts when the valuation interst rate changed. Or have I confused myself between amount of profits and value of profits?

 

[morrisja]

Been a while since I've thought of this stuff but anyway...

See attached sheet for an explanation of your example. You've left out the growth of free assets in your calculation which throws off your answer.

I've done this as if the valuation basis is set and we change it, so there's a release of reserves at time zero, but this could just be considered free assets and treated the same way, I've just included it explicitly in the calculation of EV.

Hopefully I'm actually right here (someone want to double check?). I certainly appear to be getting expected results (i.e. when the RDR is zero EV of both scenarios are the same)

 

[razen]

Thanks a lot!!!