Use of volatility adjustment for WP or UL business

Discussion in 'SA2' started by Max Clinton, Apr 23, 2020.

  1. Max Clinton

    Max Clinton Member

    Hi, I have a question on the use of volatility adjustment for WP or UL business.

    So the purpose of the VA is to reduce the risk of forced sales of assets (bonds) in the event of extreme bond movements. It does this by increasing the risk free rate used to discount liabilities, thus reducing the value of liabilities to offset the fall in asset values.

    So would the VA be able to be used for UL/WP business where these were (say) invested solely in equities not bonds? This would be beneficial as we could project forward unit fund / asset shares at a higher risk free rate which would increase value of proportional charges (UL) / reduce chance of guarantees biting and so reduce cost of guarantees (WP). So in both cases this could reduce the SII BEL, but would this be allowed?

    Thanks,

    Max
     
  2. studier

    studier Keen member

    In the UK, you are not allowed to use VA for UL.

    You can for WP but your portfolio must mee certain requirements and requires PRA approval in the UK. I am not sure of the precise details but presumably requires a certain amount of bonds and a reaonable mix.

    In terms of WP CoG calculations, the EIOPA rules aren't that specific and I have seen interpretations saying that you either should or shouldn't increase the rate asset shares are projected at but in both cases you can increase the discount rate use for dicsounting the guarentee payoffs.
     
    Max Clinton likes this.
  3. Max Clinton

    Max Clinton Member

    Thanks studier!
     
  4. mugono

    mugono Ton up Member

    Studier has provided a good answer within the UK context.

    Solvency 2 leaves it up to individual member states to decide whether firms in their jurisdiction require supervisory approval to apply a VA.

    Some countries, eg UK took up this option whilst other countries, eg France did not.

    The implication for French insurers is that they can apply a VA to all liabilities.
     
    Last edited: Apr 26, 2020
    Em Francis likes this.
  5. Lindsay Smitherman

    Lindsay Smitherman ActEd Tutor Staff Member

    Hi Max - just to the add to the (very good) answers you have had already:
    • One of the PRA requirements is effectively that the business on which a VA is approved has to have sufficiently 'predictable' liability cashflow (this relates to meeting the liquidity management part of the approval process). In the UK, I understand that VAs are most likely to be applied for on an annuity portfolio which has not met the MA criteria or (as indicated above) WP business (where there is sufficient underpinning guaranteed benefit to meet the predictability requirement).
    • However, the SA2 Core Reading doesn't go into this amount of detail and also, as indicated above, different approaches are taken in different EU countries. You therefore don't need to be concerned with this level of detail for the exam and could simply consider a VA to be a 'maybe' whatever the type of business (unless an MA is already in use on that business, of course).
    • Remember that the VA is based on a representative portfolio of assets - it doesn't matter what assets the company is actually holding: the risk-free rates that the company can use, including the VA, are absolutely set by EIOPA.
    Hope that helps.
     
  6. Max Clinton

    Max Clinton Member

    Thanks mugono and Lindsay for your added explanations :)!
     

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