zeroising cashflows to calculate reserves

[abcdefg]

For the non unit reserves there is the method of zeroising cashflows to calculate the reserve. Why is this approach used rather than taking the net present value of the future cashflows by discounting each one at the appropriate discount rate? Does zeroising cashflows result in a lower reserve being held?

I am also trying to understand why this method is not used for without profits policies. I thought it might be because non unit fund cashflows are less smooth and predictable (e.g. charges depend on unit fund size). But I assume that unit reserves need to be projected in an approximate manner with assumed asset growth rates and premiums received so the cashflows are estimated to be smoother than they really are, so the non unit reserves would also project in a smoother manner than they would in reality.

If so, then why isn't the same zeroising method used for a without profits contract e.g. a complicated one where a cashflow method is necessary.

 

[Sisyphus]

Hi abcdefg

The method of zeroising non-unit cash flows is only used for unit linked products. For other product types, i.e. 'conventional without profits products', and 'with profits products', the discounted present value of future cash flows method is used, as you describe in your question.

It is possible to use DCF for unit linked products, however the reason this is not done is because of how a regulator might require the company to set the reserves for unit linked business. In any case, what the zeroisation method sets out to do, is to eliminate future valuation strains in the non-unit fund. This means for example, that you cannot offset a negative cash flow of -10 at t = 1, by a positive cash flow of, say, +100 at t = 2. Even though the NPV is positive, you must still set up a reserve now (t=0), to pay the -10 when it occurs in a year.