Hello All, Thanks for anticipated responses. Sept 2010 Q1 discusses capital requirements for a realistic basis life company. The question introduces a company that has Peak 1 biting. The question states: 'Discuss the factors that could cause the other peak to bite.' One of the points in the answer states: If the company were invested in assets that were shorter than the guarantees on the with profits business they were backing, then an increase in the yields would result in an increase in Peak 1 surplus (as the reduction in the liability would be greater than the reduction in the asset value). However under Peak 2 the assets and liabilities (if using a retrospective approach) would move in line with each other, the only effect would be a second order impact on the cost of guarantees.' Is anyone able to explain that point to me? I understand that the mathematical reserves use a discount rate that must be less than or equal to 97.5 of the risk adjusted yield on the backing assets, but I still can't seem to understand the point that is being made. Thank you! Always Trying
For Peak 1, we are discounting the liabilities at the same interest rate as the return on the backing bonds (actually the liabilities are discounted at 97.5% of the risk adjusted return, but the difference hardly matters here). So if yields go up then bond prices come down as do liability values. As the assets are shorter than the liabilities then the liabilities fall by more than the assets and the Peak 1 position improves. For Peak 2 the liabilities are primarily based on the asset share. Any fall in asset values will be exactly replicated by an identical fall in asset share. So the Peak 2 position doeas not improve. So as Peak 1 has improved and Peak 2 has not, it is now possible that Peak 2 is biting. Best wishes Mark
