Chapters 18 (Analysis of Surplus) and 20 (EV)

[revillon]

Chapter 18 Analysis of Surplus

1) Q18.12 - In the second paragraph, it states that a negative item (actual surplus smaller than expected surplus) could be caused by fewer than expected surrenders if surrender values are less than reserves or by more than expected surrenders if surrender values exceed reserves.

I understand that actual surplus being smaller than expected surplus would be caused by more than expected surrenders. Why would fewer than expected surrenders caus this, since reserves are more than surrender values paid out?

2) Q18.15 - the solution states that new business surplus would be depressed if new business were analysed before mortality

Can I clarify, based on looking at the formula of the new business item, that many early deaths would means valuation premiums (PN) lower than acutal new business initial expenses since the policies are no longer in force, as well as higher EDS (contribution from new business to the expected death strain)?

3) Pg 20 of the Notes (Section 5.1) - the notes state that for with-profit funds, the correlation between asset and liabilities are much lower for regulatory-peak valuations, especially where a net premium valuation method is used.

Is this due to the fact that under Peak 1, the valuation bases are specified with no direct relation to each other eg assets are subject to admissibility limiits, statutory liabilities are based on prudent assumptions (and in the case of net premium valuation, implicit assumptions). My second question is why is the correlation lower for net premium valuation?

Chapter 20 Profit Reporting

4) Pg 4 of the Notes (Section 1) – The 4th paragraph states that MSB profits are based on statutory reserves. Can I clarify if this still refers to Peak 2 in the case of Realistic-basis life firms. Chapter 19 relates MSB liabilities to using Peak 2 reserves as the basis.

5) Pg 5 of the Notes (Section 2) - The Core Reading states that profit can be defined as the change in embedded value over the reporting period plus profit transfer.

Since change in embedded value is the profitability of existing business at end of period (which includes future profits from new business sold in the period) less that at the beginning of the period, plus change in net assets attributable to shareholders (shareholder value in respect of free assets in the insurance fund). Therefore the profit transfer referred to in the Core Reading refers to shareholders transfer to the shareholders fund? I am a bit confused as to what this profit transfer per the FSA Returns.

Cheers for the advice given!

 

[Mike Lewry]

Let's see what can be said to help you out:

Chapter 18 Analysis of Surplus

1) Q18.12 - In the second paragraph, it states that a negative item (actual surplus smaller than expected surplus) could be caused by fewer than expected surrenders if surrender values are less than reserves or by more than expected surrenders if surrender values exceed reserves.

I understand that actual surplus being smaller than expected surplus would be caused by more than expected surrenders. Why would fewer than expected surrenders caus this, since reserves are more than surrender values paid out?

The key question to ask is "how do surrender values compare with reserves?" If SVs are lower than reserves, then each surrender results in a release of statutory reserves, so the more the better, as far as this year's surplus is concerned. So fewer surrenders than expected will mean less release of reserves than expected, and hence a statutory loss this year.
If SVs are higher than reserves, then each surrender will reduce this year's statutory surplus, so more surrenders than expected will lead to a statutory loss this year.

2) Q18.15 - the solution states that new business surplus would be depressed if new business were analysed before mortality

Can I clarify, based on looking at the formula of the new business item, that many early deaths would means valuation premiums (PN) lower than acutal new business initial expenses since the policies are no longer in force, as well as higher EDS (contribution from new business to the expected death strain)?

Actual new business initial expenses are recouped over several years and may well exceed the first year's valuation premiums even with no deaths. But yes, many deaths will reduce P(N).
EDS(N) and V1(N) will also be reduced by having many deaths, because there will be fewer policies in force at the end of the year.
The key point being made by this question is that the surplus calculated for each source will depend, perhaps significantly, on the order of the analysis.

3) Pg 20 of the Notes (Section 5.1) - the notes state that for with-profit funds, the correlation between asset and liabilities are much lower for regulatory-peak valuations, especially where a net premium valuation method is used.

Is this due to the fact that under Peak 1, the valuation bases are specified with no direct relation to each other eg assets are subject to admissibility limiits, statutory liabilities are based on prudent assumptions (and in the case of net premium valuation, implicit assumptions). My second question is why is the correlation lower for net premium valuation?

Partly as you say, and also due to the fact that TB is not typically reserved for, so a large undistributed unrealised gain can have a big impact on assets, but little impact on liabilities.
A net premium valuation is, by construction, relatively insensitive to changes in basis. Fo example, a reduction in interest rate will increase both the value of benefits and the net premium being valued, so the overall liabilities will move less than the assets are likely to (see ST2 for a reminder of this, if you wish).

Chapter 20 Profit Reporting

4) Pg 4 of the Notes (Section 1) – The 4th paragraph states that MSB profits are based on statutory reserves. Can I clarify if this still refers to Peak 2 in the case of Realistic-basis life firms. Chapter 19 relates MSB liabilities to using Peak 2 reserves as the basis.

This comment relates to figures taken from Peak 1, so won't apply where Peak 2 figures are available. I've made a note to make this clear when we next update the Course Notes.

5) Pg 5 of the Notes (Section 2) - The Core Reading states that profit can be defined as the change in embedded value over the reporting period plus profit transfer.

Since change in embedded value is the profitability of existing business at end of period (which includes future profits from new business sold in the period) less that at the beginning of the period, plus change in net assets attributable to shareholders (shareholder value in respect of free assets in the insurance fund). Therefore the profit transfer referred to in the Core Reading refers to shareholders transfer to the shareholders fund? I am a bit confused as to what this profit transfer per the FSA Returns.

Cheers for the advice given!

I'm not sure I fully understand the question, but here goes:
If we're interested in the profitability of the long-term fund, then we need to allow for any profit transferred from this fund to the shareholders' fund over the year; this will be the shareholder transfer, which can be found in Form 58, Line 13.
However, if we're looking at the profitability of the whole company, including the shareholders' fund, then this won't be affected by transfers between funds and the "profit transfer" that needs to be added back in is the amount of any dividend actually paid out to shareholders. This dividend amount isn't available from the FSA Returns, but will be detailed in the Companies Act Accounts.