X2.2 (i)

Hi!

The solution on page 7 states that the main differences between the mathematical reserves calculation for a realistic-basis life firm and those for a regulatory-basis only life firm are:

1) Mathematical reserves for conventional with-profits business may be calculated using a gross premium valuation method with no allowance for future discretionary benefits.
2) For with-profits business, the assumed maximum reinvestment rate is a forward gilt rate that is deemed to be risk free and, therefore, requires no risk adjustment.


My questions are as below:
1) Realistic-basis life firm has the option of using gross premium valuation method but has to allow for the need to meet TCF requirements, therefore the GPV method should allow for future discretionary benefits. Whereas if a realistic-basis life firm uses net premium valuation method, it does not need to allow for future discretionary benefits. Is my understanding correct?

2) Why does ans 2 above applies to realistic-basis life firm but not regulatory-basis only life firm?


Thank you in advance.

 

Hi

Question 1
1. The quick and easy answer is because it's covered under Peak 2 (RBS).
Therefore the regulations give some slack to realistic basis firms reporting Peak 1 numbers.

2. Using a net premium valuation method is actually more prudent than using a GPV for with-profits business. That is THE reason why regulatory basis firms have to ensure reserves are at least the NPV amount. Realistic basis have a choice BECAUSE they perform a Peak 2 valuation.

Question 2
Perhaps someone else can answer this categorically for you.

My best guess is it has something to do with regulatory-basis firms not adopting a market-consistent approach in setting discount rates & therefore reinvestment rates.

In terms of preparation for the exam, question 1 is more relevant than question 2, which doesn't require real understand but merely regurgitation of the fact.


Hope that helps

 

I don't believe your statement regarding GPV is correct. My understanding is that they do not need to allow for future bonuses at all in Peak 1 as a full valuation of these is performed in Peak 2 (and the WPICC will reflect this if one exists, if there's no WPICC then the guaranteed benefits in Peak 1 are more onerous than the realistic GPV with allowance for bonuses).

For part 2 I'm not quite sure.. Reinvestment risk is not covered in any detail as far as I recall.. something vague about restrictions on max yield. A regulatory basis only life firm will calculate the valuation interest rate based on the risk adjusted return of the backing assets subject to a maximum of 97.5% of this return.. But I think for Peak 1 a Realistic basis life firm will do the same and then use the risk free yield curve for Peak 2.

I might take a look at this question & answer.. maybe something else will come to me.

 

Question 2

Thank you for the answers. Can anyone please help with question 2?