Reserves

Why are the reserves held usually larger for single premium contracts versus regular premium contracts?
Thanks

 

reserves=pv (future bens) - pv (future prems).

Do the maths!

 

It is because of the difference in the timing of the cash flows for single premium and regular premiums.

Single premium would be received at point-of-sale. Let's say the policy comes onto the book in October. We may need to calculate reserves at say December (either financial year-end valuation or interim valuation). In this case, if we say use GPV method of calculating the liabilities, [Expected PV future outgo] + [Expected PV future expenses] - [Expected PV future premium income], and the [Expected PV future premium income] will be zero (i.e. no future premiums are expected as at December).

You may wonder what will happen to the single premium that is in excess of the reserves required (e.g. if we received 100,000 single premium in October but the GPV reserves calculated is say 80,000 at that time). This difference will already have been accounted for in the company's net asset value

With recurring premiums, the [Expected PV future premium income] will be a non-zero value. Hence GPV reserves will decrease compared to the single premium case. In this case, the addition to the company's net asset value as at the point of sale could be zero.

 

I understood why reserves for single premium would usually be more than that for regular premium. I understood the part relating to the difference in timing of the cash flows. However, I did not understand the part relating to net asset value. Could you please use the same example, may be and explain the change in net asset value at the point of sale for both single premium and regular premium. I would also like to clearly understand why the company's net asset value as at the point of sale could be zero for recurring premiums. Thanks.

 

Hi LN7982,

As a matter of fact, Net Assets (of these particular policies, not of the entire portfolio of policies) may even be negative causing new business strain for regular premium policies depending on the difference between the pricing and valuation assumptions and also the expenses of setting up the policies (at the point of setting up the policy)

 

If single premium of 100,000 (Asset) is received at the point of sale and the reserves required at that point is 80,000 (Liability) then the change in the net asset value holding everything else constant is 20,000. Much profit is released immediately at the point of sale.

For regular premiums, addition to net asset value at the point of sale could be zero if recurring premiums is in arrears (not taking into account the initial expenses and reserves required at the point of sale - if we include this then we have a new business strain). Much profit is likely to be released later in the policy duration.

I am thinking in terms of EV. If we assume a same EV, then if NAV (surplus of insurer as of now) goes up then PVIF (PV of surplus to arise in the future) will come down and vice versa according to timing of release of profits.

 

Thanks, Kidstyx & Jollyfakey for the explanations. I now got it.