Solvency (Application Question) - September 2002 Question 6

Re: September 2002 Question 6

I don't understand some parts of the solution to question parts (ii) and (iii). Please see my queries in red

A life insurance company writes business solely through its own salesforce. For many years both the total new business production and the size of the salesforce has been stable. In the last year there has been a reduction of 50% in the size of the salesforce, with the average production per salesperson remaining unchanged

(ii) Explain how this change might affect the solvency position on the supervisory basis at the next valuation date compared with the end of the previous year.

(iii) Discuss how the solvency position might change in future years if the new salesforce and average production persists

Solution to part (ii)

Current stable state means that new business strain is balanced by surplus from previous years' business.

Surplus from previous years' business is in amount for Assets?

New business volume will be half of previous.

Strain will reduce in first year, previous years' surplus will be unchanged, so supervisory solvency should improve considerably.

If I am correct that previous years' surplus is included in Assets then this would stay the same and the Liabilities will due do the reduction in the new business strain?

Full effect of reduced strain not felt in first year, due to time taken to scale down operations, extra staff severance pay, etc.

Can you explain the above sentence?

Solution to part (iii)

Over the next year or two solvency may improve further, as acquisition expenses reduce to the new stable level.

Total annual profit will gradually stabilise as more of the existing business reflects the new level of sales

What does the above mean by total annual profits stabilising? Does it mean total annual profits will reduce because of lower existing business?

The new stable level of acquisation expenses (per-policy) will be higher than before, because of fixed overheads.

Fixed overheads in the above sentance means a proportion of total fixed overheads that is relevant to the set up of the policy. For example some of the cost of electricity would be included in the acquisation expenses. Am I correct?.

Maintenance expenses will reduce as renewal volumes fall: per-policy level will stabilise at more than 50%, again due to fixed overheads.

Again a proportion of total fixed overheads would be included in maintenance expenses?

Increased per-policy renewal expenses will be reflected in the valution basis: this will cause an immediate valuation strain (reduction in solvency) in the year of the basis change.

Solvency position will depend on how much surplus is distributed each year.

Any surplus distrubuted will reduce the profit and the Assets will grow less?

The decreased efficiency will make per-policy profit reduce or even becomes negative.

What does this mean by efficiency? Why would efficiency decrease?

If profit still positive then company will stabilise its solvency position with a smaller level or annual profit distribution than previously.

What does this mean by solvency position will stabilise?

Am I correct that profit here is [A(time t+1) - A(time t)] - [ L(time t+1) - L(time t) ]

If loss-making, then the solvency will deteriorate its solvency position indefinitely even if annual surplus distributions are reduced to zero.

Assets will decrease?

Many Thanks

 

September 2002 Question 6

Each year, the surplus arising from in-force business is enough to cover the new business strain from the current year.

Yes, the same surplus will now be more than enough to cover the reduced NBS.

Overheads can't be halved immediately, so NBS not halved.

Will reduce initially yes, as lower NB works its way through to being lower in-force business, then it will stay constant.

Fixed is fixed, not a proportion. For example, the maintenance costs of a NB processing system are independent of the volumes of NB, so are fixed.

Eg the costs of running the valuation system.

Surplus/profits paid out to shareholders will no longer be in the company's assets, so won't count towards solvency. Surplus/profits distributed to WP policyholders by way of an increase to guaranteed benefits will increase their liabilities and so won't count towards free assets..

Lower economies of scale

Move to a new constant level.

Your formula represents surplus arising over the year.

Eventually yes, as claims and expenses will exceed premiums.