Hope to gain some help from any of you!! Great thanks in advance. Firstly, would need advice on the validity of the following statement. "In general, the allowance for future bonuses varies according to the profit distribution method. For contribution and revalorisation methods, the allowance is usually made through using premium basis for valuation purpose while for addition to benefit method, GPV and NPV (with deduction on valuation rate) are generally adopted to include future bonuses in reserves" Why it is less suited to use premium basis as valuation basis for the addition to benefit method, in allowing for future bonuses? Also, as I do not have any exposure to contribution and revalorisation methods, would like to understand the general reserving approach under these methods. Is it simply using premium basis for reserving purpose, similar to the above statement? Would the premium basis contain explicit allowance for future bonuses or it simply assumes prudent assumptions which imply some future bonuses due to the expected margin released in future? I am also confused with solution to the Specimen Exam Question under Chapter 21 (in particular part (ii)). What I am not getting is the following part of the solution: "If valuation is performed using premium basis assumptions, then in theory there would be no need to reserve for any future profit distribution at all, as no future profits would be expected to be earned on the valuation basis" I would have thought that there is already some allowance for future bonuses when premium basis is adopted for valuation purpose as the premium basis assumptions are very likely to be prudent of which the margin would be released as bonuses in future if future actual experience turns out to be better than the premium basis. As such, future profits (which is then distributed as bonuses) are implicitly allowed under premium basis; hence the part where no future profits would be expected to be earned on valuation basis (which is the same as premium basis) seems rather confusing.... In addition, the subsequent part of the solution says that to be consistent with PRE, future profit distribution that we would expected over the next few years should be included. Isn't that we have already allowed for future bonuses using the premium basis as valuation basis? Why do we need to explicitly allow for future bonuses again using GPV or NPV? I understand this thread would be somewhat overkill but really appreciate your help!! THANKS THANKS!
My understanding is that it would be the second, ie the premium basis would use prudent assumptions (rather than having explicit allowances for future bonuses). As time goes by and thse assumptions (hopefully!) turn out to be more prudent than what really happens, then surplus emerges As the valuation basis = premium basis, we don't see the "actual experience being better than we expected" described above. In other words, the valuation experience is the same as the premium basis assumed, so no surplus emerges, so there's no future profits and so no future bonuses to reserve for. The previous point suggests making no allowance for future bonuses as (under valuation assumptions) there won't be any future bonuses as there are no future profits. If the company is currently paying bonuses, it can't assume these fall to 0 immediately at the valuation date, so need to reserve for reducing them gradually from current levels. Best wishes Lynn
