Hi The question asks how (c) requiring undiscounted reserves to be held, can affect the modelling of insurance risk. The answer states that as long as profits are treated separately, there should be no effect on insurance risk capital. Does this means that discounting reserves indirectly allows for profits (from investment income) ? Thanks.
Hi jensen, The size of the reserves will be affected by whether they've been discounted or not. Undiscounted reserves will be higher. If we set higher reserves now, then our reported profits will be lower now ie we will have deferred the recognition of profit. This, in itself, doesn't change the actual profit situation - just the timing of the reported profit. Neither does it change the insurance (underwriting and reserving) risk, so there would be no effect on the insurance risk capital. [If the profits and the capital requirement were added together and treated as one item (which may sometimes be the case) then there would be an effect, driven wholly by the change in the apparent profits from not discounting.] I hope that helps, Coralie
Thanks Coralie This next question maybe a bit stupid, but how do you "treat the profits separately"? Is it by not discounting the reserves? Thanks.
Hi jensen, I think "treated separately" here just means considered separately. For example, you could say that the capital required is 4% of premium and the profits are 3% of premium (ie treated separately); or you could say that the profit and capital requirements together are 7% of premium. I wouldn't worry too much about this... Coralie
