Hi,
In Sept 2011, Q4 part iii, Can you please explain how increasing the level of prudence will impact EV of With Profit contracts in 2 parts i.e impact on net assets and PV of future profits?
Hi Komal
This was a very tricky question. We cover with-profit surplus distribution in much more detail in Subject SA2, so it's quite difficult to see what is going on here for Subject SP2.
The Examiners Report gave the following solution:
"For with profits business, the company should be projecting the expected
bonuses based on asset shares. Any release of prudence in the reserves which
are more than required to cover the bonuses driven by asset shares would be
subject to management discretion in terms of how or when it is distributed.In
effect this is no different to the treatment of the excess of the assets less the
liabilities, and is unlikely to make a material difference to the EV."
Normally we would want to look at the impact on EV using the 2 parts as you suggest, but the examiners have not done this here. That's because the concept of a present value of future profits doesn't really apply to with-profit contracts. For unit-linked and without-profits contracts the shareholders will be receiving the future profits (due to actual experience being better than the reserving assumptions). But this is not how with-profits works. Instead for with-profits contracts the shareholders typically get some share of the surplus distribution and the key factor to consider here is the asset share (rather than the reserve) and the resultant bonuses.
So the examiners report is saying that changing the prudence in the reserves is probably not going to change things much for the with-profits EV. Instead the asset share and hence the bonus declarations are what matters. Anything that increases the asset share will ultimately lead to higher bonuses and hence higher shareholder transfers and higher EV.
Best wishes
Mark
