Chapter 23 - Supervisory reserves and capital requirements (1)

Question 1

What are the purposes of reserves

Answer 1

IS ALIVE

• to determine the liabilities to be shown in INTERNAL management accounts
• if SEPARATE accounts have to be prepared for the purpose of supervision of solvency, to determine the liabilities to be shown in those supervisory accounts
• to ASSIST with the assessment of reinsurance arrangements
• to determine the LIABILITIES to be shown in the insurer’s published accounts
• to influence the INVESTMENT strategy
• to VALUE the insurer for merger and acquisition
• to ESTIMATE the cost of claims incurred in recent periods and hence provide a base
  for estimating the future premiums required to attain a given level of profitability

Question 2

What are the uses of investigating the realistic / “true” position of the company

Answer 2

• To help demonstrate the long-term sustainability of profit distribution rates (such as bonuses) and hence to help determine current bonus declarations
• To help determine the realistic profitability of the company for the information of shareholders (etc) and management
• To assist in the general financial management of a life company

Question 3

What are the two primary reserving methods

Answer 3

• Gross premium valuation
• Net premium valuation

Question 4

Define Gross premium valuation method and what is its formula

Answer 4

This method is for placing a value on a life insurance company’s liabilities that explicitly values the future office premiums payable, expenses and claims, with the latter possibly including future discretionary benefits

Sum Assured + Renewal expenses - Office premiums

Question 5

Define unit reserves

Answer 5

It is part of the reserve that a life insurance company needs to set up in respect of its unitised contracts. The unit reserve represents its liability in terms of the units held under the contracts

Question 6

How would you calculate the unit reserve for a unit-linked policy

Answer 6

It is the number of units multiplied by their bid value

Question 7

How would you calculate the non-unit reserve

Answer 7

It is the PV of the excess of non-unit outgo (eg expenses, benefits in excess of the unit fund) over non-unit income (eg charges, unallocated premiums).

Question 8

What may regulations specify in terms of the non-unit reserves held?

Answer 8

• The sum of the unit and non-unit reserve for a policy should not be less than any guaranteed surrender value
• The future profits arising on the policy with the negative non-unit reserve need to emerge in time repay the ‘loan’
• In aggregate, the sum of all non-unit reserves should not be negative

Question 9

What are the salient features of the gross premium method

Answer 9

• An explicit allowance is made for expenses
• An explicit allowance can be made for vested and expected future bonuses
• The future premiums valued are the actual (‘Office’) premiums expected
• Any difference between the pricing and valuation basis will immediately be taken as profit or loss
• Reserves may initially be negative for non-linked business, partly due to initial expenses and partly due to capitalising the expected future profit
• The reserves tend to be quite sensitive to changes in basis

Question 10

How is the net premium valuation method calculated

Answer 10

It is calculated as the Present value of expected future benefit outgo less the Present value of future net premiums

The present values are calculated on the basis of interest and mortality only. There is no explicit allowance for expenses.