Release of Surplus and WP pols

In Q & A bank 4.4 there is an example of the effect on the EV of various changes to the business. Can someone help my understanding of how WP pols are affected by changes to the valuation basis.

If the valuation basis is weakened I would expect reserves to fall, and the release of surplus to happen faster. Would this then not increase the rate of surplus distributed to Shareholders and hence the EV?

Thanks

 

On WP business, the EV is determined by shareholder transfers and shareholders share of Net Assets. The shareholder transfers will be calculated as (1/9 say) of the COB. This would require future bonuses to be projected from assets allocated to back asset shares and guarantee cost (or possibly the full WP assets) rather than statutory reserves. So the statutory reserves decreasing will not affect the undiscounted bonus projected. Shareholder's share (1/9) will then be valued on statutory basis which in this case is weaker so less value placed on it.

The Net Assets (i.e. remaining) after the allocation above, will also be unchanged, by the reserves decreasing, assuming that everything is working based on asset shares as opposed to statutory reserves.

So in summary if the asset allocation in not done using statutory reserves then I would expect its movement not to impact the WP embedded value. Though the basis will affect the shareholder transfer. Note that explanation above assumes no interaction from NP business within the fund.

 

How will this be affected?, if you do the projections of shareholder transfer based on Asset Share (rather than statutory reserves) wont you be discounting it still based on EV assumptions which would be unchanged.

Cheers

 

I don't understand this also. In all the answers when it talks about calculating sh/h share of bonus it always says

For eg April 2006 q 1

"It is therefore first necessary to project these future bonuses, again likely on a best estimate basis.

This is likely to be done by using (explicit or implicit) bonus rates that ensure that asset shares are paid out at maturity (option A), assuming an appropriate split between regular and terminal bonus. Alternatively, current bonus rates could be assumed to continue unchanged into the future (option B).

The future projected bonuses can be used to determine the shareholders transfers in each future year, which can then be discounted at the risk discount rate.

The shareholders share is calculated as 1/9 of the cost of reversionary bonus on the statutory valuation basis, plus 1/9 of projected terminal bonus (or 1/10 of the excess of asset share over guaranteed benefits).

Can someone please give us a simple example of this - why does it always say the cost of bonus is on statutory basis but then says the bonus is derived from best estimate projections?

 

The shareholder transfer (1/9 of COB) is valued on statutory basis. This includes discounting which will be also on statutory valuation discount rates.

 

Then why do the answers make the following comment?

"It is therefore first necessary to project these future bonuses, again likely on a best estimate basis."

 

Is it because you project the bonus you want to declare on a realistic basis

But what shareholder get is 1/9 of the the cost of declaring that bonus on a statuary basis

 

Can someone please give as a simple example of this? Numerically

 

Pretty please?

It seems many of us are struggling with this concept

I think a numerical example would be very beneficial.

Thanks

 

ok here is my made up numbers

say we have asset share of 100, current sum assured of 80, policy maturing in 1 year time.

our best estimate of investment return is 5%.

In 1 years time, we expect asset share to grow to 105- so company decide to declare RB of 10 as it can afford to do so

say our valuation rate of interest is 2%.

to be able to meet the extra reserve of 10 in a year time, lets say the reserve increase by 10/1.02 = 9.80. This is the cost of the RB declared.

the shareholder would then get 1/9 of 9.80 which is 1.09 right away.

as a side point, the realistic present value of what policyholder is getting is 10/1.05 = 9.52

shareholder get 1.09 now

which is slightly higher than the 1/9 ratio [9.52/1.09 = 8.7]

Tutors, please do comment if my logic is wrong.

 

Thanks for that Benny, if I understand what your saying is that the bonus is declared in 1 years time, however I dont understand for EV purposes why you discount that using reserving assumptions. I would expect that because the bonus will be declared in 1 years time that you should be discounting 10 at EV assumptions. Any thoughts?

Back to the original question and example, my current logic is as follows. Can anyone comment on this?

Weakening the valuation assumptions (but leave the allowance for bonus in valuation method unchanged) will reduce the liabilities but will have no affect on the assets. This in effect means that your assuming that there will be a greater scope for terminal bonus as A-L has increased. This should impact the EV as the timing of the TB will be later???

 

This is because at the moment, the shareholder gets 1/9 of the cost of bonus declared on Form 58 of the FSA returns, which is on the peak 1 statutory basis.

so say we declared the the bonus of 10 as in my example. we need to increase the reserve by 9.8 (which is the cost of declaring this bonus), otherwise we will be under-reserving for the bonus declared on a peak 1 basis as the statutory valuation rate of return is 2% in my example.

 

Should've added this in as well to my previous post to answer the question

say if we weaken the valuation basis to 3% interest rate

the cost of declaring bonus of 10, will increase our reserve by 10/1.03=9.7
which means the shareholder now get 1.078, which is less then what the shareholder is getting before on the stronger 2% basis.

thus weakening the valuation assumption decreases what shareholder get.

As dok87 pointed out, the company's free asset probably won't change due to the fact that the company uses asset share to calculate the projection. Changing the valuation basis, won't change our asset share. Hence the free asset on a realistic basis, which is total asset less asset share, won't change.

 

That is brilliant thanks guys its very clear now.
I work in Ireland and there is not a lot of WP business here so its difficult to understand this type of thing. It would be great if the Acted notes had some examples like this for WP business.

 

I agree - great answers. Thanks so much!