Smart revise says that strengthening the statutory valuation basis will have the effect of (probably) increasing the PV of future profits on a block of existing WP business (but may reduce). Surely strengthening the basis will reduce free assets and hence investment freedom leading to lower expected future profits? Help?
bare in mind i am not doing ST2 but i believe the answer is as follows: when you value liabilities, you are considering the PV of future cashflows (i.e the future profits from the block of existing WP business). Therefore when you strengthen the basis, you are assuming a high value on the liabilities relative to the assets held to back it therefore you will have a higher provision set to meet your liabilty obligation, which will restict your capital use and restrict your investment strategy. I think you are getting confused with a 'weak' basis which places a low value on your liabilities relative to assets held to back it...in which case this will give you a lower provision in which to meet your future liability andhence more capital and freer investment strategy.
For a WP policy the PVFP is calculated as the present value of future transfers to the shareholders. In a reversionary bonus scenario where the bonus is distributed on termination of contract the transfer is calculated on the valustion bases. Therefore when you strengthen the valuation basis the transfers to sharholders will increase and so will the PVFP. I hope this helps.
Effect on PVFP of changing valuation basis The most significant factor here is that when the valuation basis is strengthened, reserves increase, so we need to assign more assets to back the liabilities (causing free assets to reduce). The actual liabilities to policyholders haven't immediately changed as a result, so all else being equal, there is now more surplus to emerge from the (greater) assets backing these liabilities. As people have said, there are also the mechanics of how surplus is distributed and the impact on investment freedom to consider, which could change the overall result slightly.
