Treatment of Expenses in Unit Pricing

[clactuary]

Hi,

I’m a little unsure at the treatment of expenses when buying/selling assets for unit pricing.

If a p/h pays a premium on an offer basis they will be charged the appropriation price (and potentially some initial charge). I understand that the appropriation price is higher than the expropriation price as we are charging the policyholder for the expenses incurred in purchasing the assets. But why should we deduct selling expenses for the expropriation price? Surely if there are still expenses to be paid on selling the assets, the policyholder should be charged for them?

I also don’t really understand what happens when the policyholder comes to sell their units (e.g for surrender) and the fund is on an offer basis, do they get the higher appropriation price (as opposed to expropriation price) because other policyholders buying units are paying them for the expenses of buying their units?

Think I'm getting a little confused - but would appreciate any help.

Thanks in advance

 

[Mark Willder]

Hi,

I’m a little unsure at the treatment of expenses when buying/selling assets for unit pricing.

If a p/h pays a premium on an offer basis they will be charged the appropriation price (and potentially some initial charge). I understand that the appropriation price is higher than the expropriation price as we are charging the policyholder for the expenses incurred in purchasing the assets. But why should we deduct selling expenses for the expropriation price? Surely if there are still expenses to be paid on selling the assets, the policyholder should be charged for them?

I also don’t really understand what happens when the policyholder comes to sell their units (e.g for surrender) and the fund is on an offer basis, do they get the higher appropriation price (as opposed to expropriation price) because other policyholders buying units are paying them for the expenses of buying their units?

Think I'm getting a little confused - but would appreciate any help.

Thanks in advance

When thinking about the expropriation and appropriation prices it's best to consider the insurer as a whole. I agree that if you start by thinking about individual policyholders it can get a little confusing.

The insurer will have many policyholders buying units each day and many selling each day. The important thing to consider is the overall net position.

First consider the situation where there are more buyers than sellers. The insurer has a positive net cashflow and will need to use this to buy more assets to increase the number of units in the fund. This is called pricing on the offer basis. The appropriation price represents the cost of creating a new unit. To create a new unit the insurer has to pay to buy the assets (at their offer price) and pay any expenses associated with the transaction. So the purchase of the assets and the expenses are both costs to the insurer (they have the same sign) and we add them together.

Now consider the situation where there are more sellers than buyers. The insurer has a negative net cashflow and will need to sell assets to reduce the number of units in the fund. This is called pricing on the bid basis. The expropriation price represents the amount received when cancelling a unit. To cancel a unit the insurer has to sell the assets (at their bid price) and pay any expenses associated with the transaction. So the purchase of the assets and the expenses have opposite signs (the expenses are a cost, but the sale of the assets is a receipt) and so we deduct the expenses from the asset proceeds.

So you are right that whether we are buying or selling, the expenses are always a cost to the insurer. But when we think of the assets, buying assets means money going out and selling assets means money coming in.

So now we have seen what happens to the insurer overall, we can now think about individual policyholders. If we are pricing on the offer basis then all transactions are done with the appropriation price. So policyholders buy at the appropriation price, but also sell at the appropriation price. This is good news for the sellers as they get to sell at the high price. Effectively some of the new policyholders are buying their units off the old policyholders that are selling.

I hope that helps.

Best wishes

Mark