Sep 2010, q2 (i)

[lenka]

Hi

The answer to the question states:
"Given that this is a policyholder projection - and not a profit test - assumptions regarding expenses, withdrawals - are not required."

I am struggling to understand why. Can anyone help please?

Also, the answer points out that:
"The level of max cover would be that at which the unit fund was always above a target amount - which could be, but is unlikely to be, zero depending on the prudence built into the parameters".

Again, can someone please explain what this means?

Thank you very much !

 

[Mark Willder]

The answer to the question states:
"Given that this is a policyholder projection - and not a profit test - assumptions regarding expenses, withdrawals - are not required."

I am struggling to understand why. Can anyone help please?

We are trying to calculate the maximum level of cover to quote to the policyholder. This is the most cover that can be achieved for the first ten years, whilst still allowing the minimum level of cover to be offered afterwards.

To do this we only need to project the unit fund. The cover is affordable as long as the unit fund is always large enough to pay the mortality charges.

So we do not need assumptions for expenses as these appear in the non-unit fund.

We also do not need a withdrawal assumption as we will be assuming that the policy remains in force until death.

Also, the answer points out that:
"The level of max cover would be that at which the unit fund was always above a target amount - which could be, but is unlikely to be, zero depending on the prudence built into the parameters".

Again, can someone please explain what this means?

Strictly speaking, we only require the fund to remain above zero. If the fund never falls below zero then the policyholder will always have been able to pay the required mortality charges.

However, the insurer would be carrying a lot of risk in this case. If the assumptions were worse than expected the fund would fall below zero and the insurer would not be able to charge the required amount.

So the insurer will do at least one of the following:

i) project the unit fund on prudent assumptions, eg low unit growth, so that the probability that actual experience is worse than assumed is sufficiently small

ii) require that the fund is always above some minimum level in the projections, so that the fund will not be exhausted if experience is a little worse than expected.

For a given level of prudence, the higher the minimum level chosen in ii), the smaller the margins in the assumptions need to be in i).

Best wishes

Mark