Hi, I'm getting a little confused between asset share calculations and surplus calculations. In case of asset shares, we are only required to look at the actual cashflows. So this does not include reserves held. However, in case of surplus, we do consider reserves held. What I don't understand is that if in case of with profits business, we declare bonuses based on the surplus and at the same time try to ensure that the asset share is close to the sum assured plus accrued bonuses, how would that link be achieved if in one case we do consider the impact of bonuses and in the other we don't? Or are we considering impact of reserves implicitly in the calculation of asset share via the cost of capital? If so, in a question where the cost of capital (in percentage terms) is provided and the reserving basis is provided, how would one calculate the actual cost of capital incurred on each policy's asset share? Please help! Thanks, Rathi
Hi You're right that asset shares don't include reserves(*). The asset share of a with-profits policy is the accumulated cashflows of that policy, ie it is basically "the amount we have" in respect of the policy. Broadly, at maturity of a with-profits policy, we will set the bonuses to pay out (as close as we want to) the asset share. (The "broadly" and "as close as we want" are for other factors such as PRE, smoothing, equity, competition... ). So, by the end of the policy term, the maturity value we pay out will reflect the final asset share (ie the actual experience over the policy term). You're absolutely right that the surplus depends on the reserves. The surplus arising over a year is "increase in assets over the year" - "increase in reserves over the year". We can think of the reserves as the "amount we need to have" in respect of a policy. The reserves have the effect of influencing the pattern of the emergence of the surplus over the policy term. So, the reserves affect the timing of the profit, but they don't affect the total amount of profit. (For the sake of completeness, I should admit that this is a simplified view of how this might actually work in reality!) We can make this type of adjustment yes. One of the possible deductions from an asset share that the reading mentions is a deduction for the costs of any capital necessary to support contracts. The idea here is that if the reserve for a policy is greater than the asset share, then broadly "what we need" is more than "what we have" for that policy. So, this policy needs to "borrow" some capital from elsewhere, and we should charge interest on this. This is not a very exact science: not all companies do it, and those that do calculate the costs in different ways. So, if the ST2 examiners did ask for a calculation, they'd have to suggest a method, eg based on charging a specified interest rate for the amount "reserves - asset share" each year. (*) If we are making this sort of deduction from the asset share for the cost of capital, then reserves do have a (second-order) impact on the asset shares. The bigger the reserves, the more we charge the policy for borrowing this capital, and so the smaller the asset share. Hope this helps a little Best wishes Lynn
