ANALYSIS OF SURPLUS

Question 1

What are the different sources for changes in surplus?

Answer 1

Surplus is either calculated on a supervisory or published reporting basis, the sources of surplus differ as a result. Sources include:

• change in valuation assumptions i.e. change in assumptions about future experience
• release of profit margin (via CSM for GMM/VFA or normally via PAA) (only published reporting)
• release of risk margin vis risk margin/risk adjustment
• difference between actual and expected (tax, expenses, mortality, morbidity, withdrawals, investment return, charges, option take-up rate)
• new business
• changes (policy alterations, in guarantee reserves)

Question 2

What does AOS result in?

Answer 2

• Improve product design (e.g., reduce mortality charges if consistently profitable)
• Update assumptions for future valuations
• Identify problem areas needing attention
• Make strategic business decisions

Question 3

Why was the formula approach well suited for net-premium valuation non-linked products?

Answer 3

• reserve is calculated as PV of benefits less PV of future net premiums
• net premiums exclude allowance for profit margin, expense margin or lapses.
• liabilities of non-linked products are not heavily dependent on investment returns
• the simpler the product, the less drivers of profitability to consider
• in net premium valuation there is a clear difference between elements which create a reserve (mortality and interest) and what creates profit (lapses, expenses etc.)

Question 4

What is the difference between AOS and AOEV?

Answer 4

AOS looks at the change in an insurer’s surplus (assets minus liabilities) over a specific period.
- identifies specific drivers like mortality/morbidity experience, investment returns, expenses, etc.
- compares actual experience to expected assumptions
- often used for statutory reporting and management information
- usually backward-looking, explaining what happened in the past period

AOEV looks at total economic value of an insurance business (ANW, PVIF).
- looks at total economic value rather than just accounting/supervisory surplus
- proof of value creation for shareholders
- includes risk adjustments and the cost of required capital
- forward-looking by nature, projecting future cash flows
- often used for business valuation, M&A activities, and performance measurement

Question 5

Compare and contrast the formula approach and projection approach.

Answer 5

Formula approach
- works well for simple products
- order not as important
- includes loads of timing approximations (1 + 0.5i)
- uses mostly actual values

Projection approach
- actual cashflow timing used
- works well for complex products (guarantees, options etc.)
- requires lots of assumptions

Question 5

When calculating EDS how do you decide on k1 and k2 factors?

Answer 5

When policies are in force the whole year
k1 is 1, because the policies have been exposed to mortality risk the whole year
k2 is 0.5, because we assume deaths occur halfway through the year

When policies are in force for half of the year (due to joining later in year/withdrawal)
k1 is 0.5, because policies have been exposed to mortality risk for half of the year
k2 is 0.25, because we assume deaths occur halfway through the exposed period