The examiner report for September 2007 q5 (i) says on term assurance business: "this may not be significant for this contract due to the low reserves" I would have thought that term assurance business would have a high reserving requirement relative to the amount of premium paid, given that a a small amount if prudence in the mortality assumption relative to the pricing assumption would greatly increase the expected benefit payouts. Am I wrong? Consequently the biggest driver of embedded value would be the release of reserves over the run-off of the business Thanks
Reserves are money you put aside to pay for future benefits and expenses (minus future premiums). If, for example, you're part way through a 10-year term assurance, how much money would you need to hold for future benefits, given the small chance of death within the term? Not much at all!
At outset though you will be receiving a relatively low regular premium, the benefit will be extremely high but the probably of payout will be low. Given the margins for prudence in the reserving assumption I thought that the reserves held relative to the premiums paid, particularly at outset would have been quite high. Relative the expected payout would be down to the strength of the margins in the reserving basis
Quick level term assurance example (ignoring expenses and profit): AM92 Select Mortality Sum assured = £10,000 Age at entry = 50 Term = 10 years Premium basis interest rate = 6% Reserving basis interest rate = 4% Annual premium = £38.92 Time 0 reserves = £19.17 So the reserves are actually only half of the first years premium, and as you can see they are very low. That's assuming that I haven't made any mistakes in my calculations!
