Hello, Q2. iii) I would like to know more about the impact of increase in mortality on estate. Specifically, if claim on death is greater than asset share, the excess of claim over BEL (AS+CoG) will be deducted from AS/Estate of remaining policyholders. How does this work practically? Assets=1000 Claim =200 AS=150 CoG=20 Assets after claim = (1000-200)=800 BEL= 150+20=170 <claim Now, excess of 30 deducted from AS of remaining policyholders. How would the accounting treatment be? We credit assets by 200 and debit liability by 200? (although we were holding only 170 liability for this policy?). Please help in understanding this bit only. Thank you!
Q1. v) Although I understood the impact of most risks, can someone elaborate on interest rate risk, spread risk and counterparty risk? For interest rate, my understanding is that given how yield is higher in country B, BEL will always be lower in B. Hence, interest rate stress will be applied to lower value of BEL. As liability exposure is lower, SCR for interest rate risk will be lower in B. I could not follow the logic of these risks in Examiner's report. Also, please confirm my understanding about the information given in question. Equity risk is 20% higher in country B. This implies that if country B were to hold same volume of equities as country A, it would have to maintain 20% more to account for higher (market) risk of equity in country B. Lapse risk- if it is 30% higher in country B. it means that the lapse assumption (lets say for endowment products) will be 30% higher in B compared with A for the same product. Thanks a lot!
It isn't the excess over BEL that would be deducted, it is the excess over asset share. The asset share of an individual policy is the amount of money that the company has accumulated in respect of that policy. If it pays a death claim out on that policy which is higher than the asset share, it has used up more money than it was holding for that policy. That money has to come from somewhere, so the company may decide to charge it across all of the other WP policies. This is done by deducting a 'cost of life cover' charge from asset shares that is based on actual mortality experience. Alternatively, the company could base its 'cost of life cover' charge deduction from asset shares on a notional (or 'smoothed') mortality rate. Then the extent to which actual experience is worse or better than that rate would fall to the estate.
In terms of the accounting treatment, on the death of a p/h there will be an outflow of cash equal to the death benefit and the liability will be reduced by the amount of liability that was previously held for that policy. Any charge for the cost of life cover (to other asset shares) will normally be done on a periodic basis, not immediately - but at some point this would be reflected within the liability calculation for those other policies, to the extent that the liability valuation approach depends on the asset share (which is probably the case, but would depend on the specific accounting principles that were being followed).
Yes that's right - but spread risk is higher because there is no matching adjustment allowed in B, so a widening in credit spread would reduce the value of assets whilst the value of the BEL would remain unchanged. The point about counterparty risk is really just saying that: if the company keeps all the business in Country A, there is no reinsurance in place. If it reinsures the business into the new subsidiary in Country B, there is now an (internal) reinsurance arrangement in place, which increases risk.
These points in the table in the Q are referring to the stresses used in the SCR calculations. So, if Country A requires a 30% equity market fall stress to determine the SCR equity risk component, Country B must require a: 50% equity market fall stress, if the 20% difference is additive, or 1.2 x 30% = 36% equity market fall stress, if multiplicative.
Alright. BEL= asset share + CoG. CoG reflects the guarantees which asset share may not cover. Hence, for claims in excess of asset share, will we not utilize CoG first and then if the claim is > AS+CoG, deduct excess from asset share of remaining policyholders? We have considered the scenario where claim = asset share. Hence CoG is entirely released and I suppose will be treated similar to release of reserve (Added to profit). I understood this part. Claim> asset share case is still not fully clear. Please help.
spread risk is higher because there is no matching adjustment allowed in B How can we establish this relation?
The actual money that has been accumulated in respect of the policy is the asset share. If the company pays out more than the asset share on claim, it has lost an amount of money equal to 'claim minus asset share'. Who pays that amount? The estate or the WP policyholders? Each WP p/h would normally contribute towards that amount on a regular basis, through deduction of a 'cost of life cover' amount from their asset share each period. You may remember this from SP2 as being broadly equal to the mortality rate qx multiplied by {death benefit minus asset share}. By deducting this cost, the company is collecting a sufficient amount across all WP policies to meet the expected excess death benefits payable over asset share during each period. If there are more deaths than expected, the amount deducted could be increased (eg by using a higher value of qx to reflect the actual higher experience) - this is basically the pooling or sharing of mortality surplus (or deficit in this case) between WP p/hs. Alternatively, the WP p/hs could continue to be charged using a notional qx and the excess death claims could be 'met from the estate'. Yes, there would be a release of some of the BEL in the Solvency II balance sheet to the extent that BEL > death claim for each additional death - but this is just about reporting, it's not about actual money. The 'CoG' set aside for each individual policy is not money that has been taken from that policyholder. It is just part of a figure (the BEL) in the supervisory returns which indicates how much of the {excess of assets over asset shares in the WP fund} is notionally ring-fenced as an estimate of what the guarantees under that policy would cost to hedge on a market-consistent basis. It aims to reassure the supervisor that guarantees could be met (or, at least, hedged out). Of course the company could also be taking charges from asset shares to cover the cost of guarantees. These will mainly reflect the inherent maturity guarantee and the cost of any guaranteed annuity options. So yes, in theory the company could take this into consideration when determining the cost of life cover deduction from asset share - but that introduces an unnecessary level of complexity into the calculation. And the idea is normally that these amounts taken from each asset share can accumulate and then be used to support the cost of such guarantees when they bite. When a p/h dies, the accumulated 'cost of guarantee charges' taken from their asset share will contribute towards the cost of meeting maturity guarantees from those that remain. I can see that there is potential for overlap between 'cost of life cover' deductions and 'cost of guarantees' deductions from asset shares, so perhaps they could be combined in some way (depending on the exact nature of the defined death benefits) - although this hasn't traditionally been how they have been treated. Keeping the 'cost of life cover' separate allows companies to better monitor and manage the distribution of (just the) mortality surplus arising. Companies would, in any case, make sure that they were not double charging. And bear in mind that these deductions are only going to be fairly broadbrush, particularly any 'cost of guarantees' deduction. The insurer wants to make sure that it is making sensible asset share deductions: ones that are broadly going to meet the additional costs in excess of asset share, and that are being taken equitably from the WP p/hs. So yes I can see what you are getting at, but in reality a simpler approach tends to be taken to mortality surplus distribution: the amount deducted from asset shares to contribute towards the cost of life cover is qx multiplied by {death benefit minus asset share}.
Spread risk stress = widening of spreads Higher spread -> higher matching adjustment (not by the full amount, but part of it) So in Country A, could increase the matching adjustment under the stressed conditions, increasing the discount rate and reducing the BEL In Country B, are not able to do this Therefore higher spread risk component in Country B
Hi, in Q2 (i) it states that the company might outsource or sell their with-profits business to protect shareholder value - Is this to do with them not having to subsidise the expenses?
Yes - it's largely about dealing with the increasing burden of overheads for the diminishing fund, although selling it will of course get rid of other issues, like investment strategy for a reducing fund, holding solvency capital etc.
Offbeat but could someone clarify if critical illness in UK (and generally) is typically single premium or regular premium? Claim is surely a lumpsum on diagnosis of identified illnesses.
Just to confirm my understanding, let's say the risk-free rate in both countries is same, should the credit spread widen, the reduction in value of assets be same (assuming same mix and strategy) however, BEL would reduce in country A because of MA and hence, spread risk is higher in country B? If yes, does that mean under SII, the credit spread risk impact would usually impact the asset side more and BEL less since MA would usually be a part of the spread?
Also, can someone please help me understand Q2.iii) impact of fall in equity? A simple numercical example would be very helpful. 1. How is the impact of fall in equity countered by fall in asset share? Is it because the rate of return on asset share also falls down by the same ratio? 2. Struggling to understand the concept of estate which is MVA - BEL (Asset Share + CoG). The answer says whether the asset mix of estate would be same or not, why would it not be the same since it appears to be the excess of Asset over Liab and assets are said to be a mix of equity and fixed securities.
Q3, v) Can someone please help in understanding the impact of fall in interest rates to the proposed investment strategy with an example? Somehow I am finding it hard to understand the concept with change in economic conditions and its impact on the overall business (assets as well as liabilities).. For instance "If the company invested assets longer than liabilities and interest rates were to fall, then the value of the assets would rise resulting in additional capital if interest rates fall So, with this strategy, the company would have to hold less required capital against the fall in interest rates risk" Here they say, additional capital first but then say less capital required. So it is a bit confusing!
Asset share = accumulation of premiums minus expenses etc etc under actual investment returns. If the asset share is backed 50% by equities and equity values fall by 10% (ie actual equity return = -10%) then the asset share will fall by 5%.
Yes but the balance between equity and fixed-interest securities might differ between the assets backing the asset shares and the assets within the estate.
