SP2 April 2022 Q6(i)

[Jenil Mehta]

In the solutions provided by IFoA, for investment returns is mentioned that "We would expect the actual investment returns to be lower than the assumptions if the basis was prudent".

Can you please explain the reason behind this statement because as per my understanding, if my assumptions are prudent then the actual interest rate should be higher than the valuation interest rate correct?

 

[Mark Willder]

In the solutions provided by IFoA, for investment returns is mentioned that "We would expect the actual investment returns to be lower than the assumptions if the basis was prudent".

Can you please explain the reason behind this statement because as per my understanding, if my assumptions are prudent then the actual interest rate should be higher than the valuation interest rate correct?

Hi Jenil

This is a typo. You are right that the actual investment returns should be higher than the assumptions if the basis was prudent.

Best wishes

Mark

 

[rlsrachaellouisesmith]

Hi

In this same question on surrenders is it correct that we would want actual experience to exceed assumptions for surrenders?

If so, is it the fact that the long term A/E is >100% and the significant increase in the year 1 A/E that means we would choose to suggest a review - because there is a risk that we are over-reserving?

Thank you

 

[Mark Willder]

Hi

In this same question on surrenders is it correct that we would want actual experience to exceed assumptions for surrenders?

If so, is it the fact that the long term A/E is >100% and the significant increase in the year 1 A/E that means we would choose to suggest a review - because there is a risk that we are over-reserving?

Thank you

Hi Rachael

No, it's the other way around.

The solution says:

"a lower number of policies in force than expected may mean that overhead expenses are not covered by charges"

So a high number of surrenders is a bad thing for the insurer. So the fact that actual experience has been worse than expected suggests that the insurer has been under-reserving and so would want to increase their surrender assumption.

Best wishes

Mark

 

[rlsrachaellouisesmith]

Hi Mark,
Thank you, but it also says in the additional comments that:

o When reserves are positive then a low lapse assumption will be more prudent A/E>100%
This is why I got confused.
If reserves are positive then these will be released when a policy lapses.

o When reserves are negative, early term then a high lapse assumption will be more prudent A/E<100%
Is this because the loan from the positive reserve will now not be paid back by the policy with the negative reserve and so more reserves need to be set aside?

Thank you

 

[Mark Willder]

Hi Mark,
Thank you, but it also says in the additional comments that:

o When reserves are positive then a low lapse assumption will be more prudent A/E>100%
This is why I got confused.
If reserves are positive then these will be released when a policy lapses.

o When reserves are negative, early term then a high lapse assumption will be more prudent A/E<100%
Is this because the loan from the positive reserve will now not be paid back by the policy with the negative reserve and so more reserves need to be set aside?

Thank you

Hi Rachael

Everything you've said in your last post is correct. depending on the sign of the reserves, surrenders could be either a good thing or a bad thing for the insurer.

But going back to your earlier post, the solution is suggesting a review because of concerns about under-reserving, ie the case where we are assuming too few surrenders. If instead the insurer makes a profit from surrenders then the assumption is probably about right - the reserves should have some prudence and so we should expect some surplus to arise each year.

So in summary, under-reserving is bad. Excessive over-reserving is bad too, but a little bit of over-reserving is actually a good thing as the purpose of the reserves is to provide a high probability that the claims will be met.

Best wishes

Mark

 

[rlsrachaellouisesmith]

Thank you Mark, that helps a lot.