ST3 April 2007 Q6

Hi I am just having a look at constructing the balance sheet for this question as there aren't many to practice on in the more recent papers. I don't understand how the free reserves have been calculated. For X, I have:

GEP = 25
Incurred claims = 30 + 35 - 20 = 45
Expenses paid = 15 + 5 = 20
Increase in DAC = 7.5
Investment income = 3
=> insurance profit = -29.5

Is this correct & how do we then get to the free reserve of 57 given in the solutions?

Thanks!

 

The free reserves are the balancing item, they were actually the last thing to calculate so that the total liabilities equal the total assets.

I see in your approach you wanted to first of all calculate insurance profit but, for example your figure for GEP there assumes that there was no UPR from the past year (which is quite a heroic assumption), but in any case, assuming you could calculate the profit, you would have needed the value of the free reserves as at the start of the year - which again we do not have.

As part of my revision, I am looking at the linkages between the PnL statement, and the Balance sheet. And also getting a good handle on the reasoning behind the assumptions. Look at the assumptions and get a good understanding of a) why they have been made, b) how they have been applied in calculating the figures in the balance sheet.

 

Thanks that's really helpful.

How is the UPR calculated here? From what I can see there is no explicit premium earnings assumption so how do we get to 25 for company X, for example?

 

That is a result of these two assumptions: 1) Risks (i.e premiums) are written uniformly across the year, and 2) Risk is uniform across the policy year ( i.e. premium [which is meant to cover the risk] is earned uniformly through the year.And also 3) All policies(business) is yearly.

1) means that on average, all of the gross written premium can be said to have been written in the middle of the year, 2) will mean that half of it will be earned in the current year, the other half will be earned in the next year.
So Unearned Premium Reserve =half of the Gross Written Premium