Supervisory Reserves

Why is the approach of using the same prudent assumptions used in the pricing basis to calculate reserves not suited to the Additions to Benefits method?

This point is made in Chapter 21, I don't understand it.

Thanks for any help

 

Bump

Any tutors around?

I'm about to go over the supervisory reserves chapters again.. I'll give a go at answering after that.

 

I just came across this in the notes and also dont understand why this comment is made. Anyone?

 

i have been trying to work my head around this as well.

If there is no one to answer, lets reason through it ourselves.

My thought is that the source of the surplus and the way it is distributed is the reason why same prudent assumptions for pricing and reserving is less suited for additions to benefits method.

Under revalorisation and contribution methods, bonuses are distributed as they emerge (less scope for deferral). Recall that under revaluation method, the reserves are increased, and under contribution method cash bonuses are distributed. What is distributed is the actual less the prudent experience.


Whilst under additions to benefits, bonuses are only added to maturity benefits hence more scope for deferral (terminal bonus). What is distributed is actual less expected experience (pricing assumption)

OK all said, i am beginning to ask myself if everything i typed makes sense

 

There are two main factors that come to my mind when considering different bonus distribution methods:

1. Method of allocation of investment and insurance surplus to policyholders and shareholders; and,

2. Timing/deferral of bonus distribution.


Since the revalorisation method and contributions method have different methods of allocating investment and insurance surplus, I think we are dealing with timing of bonuses in the additions to benefits method.

Deferral of bonuses would usually not be preferred by either policyholders or shareholders and insurer should aim to meet the policyholders' reasonable expectations and shareholders' expectations regarding share of cost of bonus (timing thereof).

If the pricing assumptions are the same as reserving assumptions, then there will be no capitalization of basis differences and hence surplus will be deferred to the times at which the actual surplus are measured. I think this is the case for both GPV and NPV methods.

 

I've been thinking about this and here is my stab at it.

I think the point it’s trying to get across here is that either

a) Price prudently but then you would have less of a need to reserve prudently (to the point where the 2 bases are equal)
b) Prince more realistically but ensure that your reserves are then more prudent.


It some parts of the world a prudent pricing basis is used and the reserving basis is set equal to this (a).
In other parts (for example South Africa) it is common to have a more realistic pricing basis with margins then built into the reserving basis (b)

For the former (a), surplus would arise when the actual experience is better than reserving/pricing basis – this method would seem to be appropriate when you want to distribute surplus as and when it arises (so contrbn and reval method)

Under an additions to benefit method, you don’t want to distribute surplus as and when it arises ( smoothing would be desirable to produce stable regular bonuses).

For this aim to be achieved the company would need to reserve on a more prudent reserving basis compared to pricing basis. So the company may makes a loss (actual experience worse than expected in pricing) but still be able to pay a bonus owing to the strength in the reserving basis.