**Ch 38: Surplus

Question 1

Key takeaways

Answer 1

• The profitability of a product or benefit is of keen interest to providers
  ~ Even if not-for-profit
• Lifetime versus arising over time
• In terms of lifetime profit, reserves only influence timing
• In terms of profit arising, reserves are very influential
• Lifetime profit can be influenced by levers (almost the opposite of risk)

Question 2

Lifetime profit

Answer 2

• Pricing basis vs what you actually experience
• Reserves are very influential
• Reduce profit by increasing reserves
• Reserving can delay or accelerate the release of profits
• Prudent valuation basis: set up a big reserve -> big new business strain -> release the reserve over the lifetime of the policy. Actual experience vs expected experience determines if/to what extent the reserve is released
• Increase profits by releasing reserves
• Pricing of the product is the main factor
• Whether you reserve optimistically or conservatively, the expenses related to the reserves will be the same.
• How does compound interest fit into all of this. How you reserve makes no difference to the overall profitability. There is an opportunity cost to holding reserves. We take capital and hold in reserves which cannot be used. Rather use the extra capital to write new business to bring in further returns.
• Reserving doesn’t change the overall profits, but rather changes the timing of the release of the profits.
• Total profit is determined by pricing. Nothing can save you if you mis-price your product.
• Releasing reserves reduces liabilities and increases owners equity. A=O+L. The released reserve changes from backing a liability to backing a reserve.
• Surplus = change in assets over time - change in liabilities over time
• Negative reserves are possible. It represents expected future profits.

Question 3

AoS

Answer 3

• We know what we expected (at time t) things to be like at time t+1
• Now change one expected thing to its actual level (choose the thing that you think will have the biggest impact). That one thing is now changed forever. Look at the B/S. A, O and L would have changed. Surplus arising is New O - Previously calculated O.
• Now change the next thing from expected to actual. Look at the B/S again
• Once everything is at its actual level, you should get a B/S pretty close to your actual B/S at t+1
• Will it be exactly the same?
• Balancing items?
• You need to figure out where surplus comes from before you distribute it.
• There are normally interaction terms between factors, that the sequential changes wont take into account.
• A small balancing item doesn’t mean that you did it right.
• There may be a big positive offsetting a big negative.
• Always do the levers in the same order in re-runs, because of interaction factors.
• If you are going to change order of factors or add or remove factors, it is necessary to go back and re-run all previous AoS’s.

Question 4

ASSA Nov 2017 P2 Q5 (moa)
Company A and Company B are two general insurers operating in the local market. Both have recently
released their financial results for the year ending 30 June 2016. From the cash flow statement, you notice
that the cash received for gross premiums and the cash paid out in claims to policyholders are identical.
When you look at the income statement, you find that the net income after-tax figure for Company A is much higher than for Company B.

i. State eight (8) possible reasons for this difference between the companies.
(4)

i Outline the levers available to a general insurance company to manage the amount of money they pay out in claims.
(3)

[Total:7]

Answer 4

Question i

1) Investment returns for A could be higher than B
2) IBNR reserve for B bigger than for A
3) Release of catastrophe reserve bigger for A than for B.
4) A has lower expenses than B
5) A has earned more premiums than B. Incurred does not necessarily mean earned.
6) A is more tax efficient than B
7) A has higher reinsurance recoveries than B
8) A has lower reinsurance premiums than B.
9) B may need to service more debt.
10) A may have higher 3rd party recoveries and salvage.
11) B may have recently launched a new product and have new business strain.

Question ii
1) Reduce claims frequency
- Better underwriting
- Higher excess (also reduces severity)
- Stricter claims management
2) Reduce claims severity
- Introduce or increase a co-payment

3) Both
- Higher excess
- Cancelling risky clients or in-force policies expected to have worse than average experience
- Tighter policy wording
- Introduce (more) exclusions