Does any know what is it for ? Why we calculate the shadow fund for unitised WP and not for conventional ? I do not see the point.
It is just that for UWP, the account value that you see has not been calculated based on the true investement return. We use some arbit bonus rate to increase the fund value every year. So at the time of deciding the payout (Surrender/Maturity/Death), you would ideally like to get the true value of the policy - This is the shadow fund and in reality is a kind of asset share calculation. Here we use the actual invstment return earned to calculate the fund value. The shadow fund for UWP is very similar to the asset share calc for a conventional one. Infact I would say its exactly the same as calculating Asset share. The difference comes in because the UWP is a fund based product where as the conventional WP has a distant SA. Think of how you would calculate the Asset share of a UWP, Is not this exactly same as what a shadow fund does?
Yes, the Shadow Fund approach and the Asset Share calculation are essentially the same (see Ch24 pg15, second to last paragraph).
The shadow fund is a convenient way to calculate the asset share as described in the two replies below. We only use it for unitised with-profits business because UWP works in the same way as unit-linked. We already have systems in place to calculate UL unit prices and so we can easily calculate a shadow unit price for the UWP fund, and hence a number of shadow units for each policy. If charges equal expenses then the value of units is the asset share for each UL policy, and the value of the shadow units is the asset share for each UWP policy. We don't use shadow units for conventional with-profits as we have no mechanism for keeping track of the units, and we don't have explicit charges that we can deduct. Best wishes Mark
Mark (and others, if anyone has any thoughts! ), just reading the last paragraph of your note above, where you are referring to "explicit charges" that we do not have under CWP... The core reading refers to cost of providing guarantees, smoothing, etc. as some of the inputs in the calculation of the asset share for CWP. Just wondering why these would not be considered explicit? Is this because they are not usually communicated to the policyholder? Also, apologies if this is a very general (or daft) question, but just wondering: when considering the calculation of the asset share for unitised WP, is there a simple way to explain the significance of using actual expenses rather than charges (or the other way around)? Does the choice depend on the level of data available, and is there a "better" option to choose, or something else perhaps..? Finally.., speaking of actual expenses and charges (just to help bring the above concepts to life a bit) - in practice, could an example of "actual expenses" be "a percentage of investments charged by the investment manager to the insurer", and could an example of "charges" be the "allocation rate"? Thanks, Viktor
Yes, that's right. If there are explicit charges being taken under UWP business (eg bid/offer spread, allocation rate, annual management charge), these form part of the contract terms and the amounts of these charges are communicated to the p/hs (ie explicit). For CWP business, there should be something in the PPFM (or equivalent) that gives an indication of how payouts are set, including mention of making any deductions to contribute towards expenses, cost of guarantees etc, without setting out exactly what these deductions are (ie implicit). For UWP business, the p/h 'sees' the development of their fund amount, including how the charges are being taken from it. For CWP business, the p/h only 'sees' the basic sum assured plus the bonuses as these are attached; they never 'see' the asset share, which is where the charges are being taken from.
If the co is deducting actual expenses, and happened to have a very expensive year (expense loss relative to expected), the deduction would be higher; if happened to have a very cheap year (expense profit relative to expected), the deduction would be lower. So the WP p/hs are receiving the expense profits/losses when actual expenses are deducted. If the co is deducting expense charges, these would typically be set at the level of expected expenses. So if there is an expense over-run (expense loss), the WP p/hs would be protected from this. But equally, they would not benefit from any expense under-run (expense profit). So the expense profits/losses are being absorbed not by the WP p/hs, but by the estate (assuming that's where the charges are going). There are some UWP products (mentioned in the course) where the p/hs share in 100% of the investment surplus but the shareholders receive 100% of other surpluses. For such a product, the charges taken therefore go to the shareholders, and it is they who would benefit from any expense profit or incur any expense loss.
Hopefully the answers to the other questions have resolved this. Actual expenses could be deducted in any form that the company chooses: per policy, % premium, % asset share etc, in the same way that charges could also be expressed in any of these ways.
Still don’t understand. Can you explain with a simple numerical example, how does a shadow fund operate parallel with what’s shown to the policyholder, for uwp? and why is having a shadow account convenient? In general, having 2 accounts for the policy would be more work than normal, what am I missing?
Policyholder sees the guaranteed benefits they have built up to date. Company also sees the shadow fund, which represents the asset share and therefore is used to determine the eventual payout, to allow them to set the terminal bonus so that guaranteed benefits + TB = (smoothed) asset share Let's say premium minus expense charges = 100 and that this is paid at the start of the year. Let's say that the regular bonus declared for the year is 1% and the actual investment return over the year is 3% Policyholder benefits seen at year end = 101 Shadow fund at end of year (seen only by company) = 103
So, would this probably be true for conventional products in a way? Because the customer sees the guaranteed benefits but at the same time, the company needs to track the actual returns to calculate the terminal bonus?
Asset shares would of course be calculated for conventional WP products too, to set terminal bonuses. But using shadow funds only really works for unitised with-profits (UWP) business, because the insurer can use the basic system set-up (increasing prices on a daily basis) to calculate both the shadow fund ('behind the scenes') and the UWP fund value (that the policyholder sees). It's also more important to have individual asset share calculations for UWP business, due to the flexibility of premiums for that type of business. That way, can make sure that each customer is receiving a payout based on an asset share that appropriately reflects the investment returns actually earned on each premium, whenever it was paid in, whatever size it was.
