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Hi


When should I include future bonuses when calculating net premium reserves. I was looking at two past papers which seem to have treated them in different ways.


The first paper is Q24 from September 2013 (see attached). The memo seems to ignore future bonuses in the net premium reserve. E.g. the reserve at time 1 doesn't account for bonuses at time 2,3 and 4.


The second paper is from Q14 from April 2012 (see attached). The question is about a decreasing term assurance and seems to include future decreases in the net premium reserves. If this was an increasing term assurance, it would be the same as a term assurance with a simple bonus. 


Why are future bonuses treated differently when calculating net premium reserves?


Also note that the 2013 one is a profit testing question whereas the 2012 one is not - I'm not sure if that has something to do with it.


Thanks

Sachinimageimageimageimage

1 Answer

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I think I understand your question but please correct me if I am wrong!


From what I can see, both questions include the "bonuses". For Q24, the reversionary bonuses are only declared at the end of each year. So the policyholder will only receive the bonus upon a claim of the policy (i.e. when they die). So even though we are expecting to give the policyholder a regular super compound bonus, these are not guaranteed. The insurer can, in theory, declare no bonus after the first year (but this would be damaging as the policyholder would expect the increase so they probably wouldn't). The insurer will usually declare bonuses based off of the profit they receive from the policy (from various sources). 

As a result, you get two kinds of bonus. One that is vested (i.e. it is guaranteed) and the other which is non-vested (or not guaranteed). Once the bonus has been declared, it becomes vested. The insurer is tied in and must provide the amount promised at the time which it is promised. In this case, it is once the bonus is declared each year and are the amounts in the table in the answer at each year. The non-vested bonuses are all the future bonuses. The policyholder will expect to get those bonuses but the insurer is not required to pay that on those dates. Since the bonuses are not vested (i.e. guaranteed), the insurer won't factor this into the net premium reserve. 

An example would be the calculation of the net premium reserve at the end of the first year. At the start of the year, the policyholder is told (not promised) that the benefits will increase at a super compound rate of 1.92....%. At the end of that year, the insurer declares the first bonus of R480.77 that the policyholder is eligible to get when they finally claim. The R480.77 is vested (guaranteed) and the insurer must pay this when the policyholder claims. The other amounts (R970, etc.) are all non-vested (i.e. not guaranteed). Until the insurer declares the next bonus at the end of the second year, the insurer is not legally liable to pay any additional benefits higher than the vested R480.77. This is why the net premium reserve doesn't factor in the bonuses in this question.

You are going to have to correct me if my knowledge is out-dated here but my understanding of the net premium reserve was that is makes no account for future expenses and future bonuses the insurer expects to pay that they haven't guaranteed). It's not meant to be a realistic look at the future and is focussing on the notional premium that is calculated. The process I followed above was how I used to do it because, for net premium reserves, you always include vested bonuses (and exclude non-vested bonuses).

When we then look at Q14, we see that you interpreted the decreasing assurance to be like a normal assurance with a "decreasing bonus". That's fine if you want to think of it that way as long as you can see that these are vested "bonuses". The insurer guarantees them and as such will have to pay those amounts at those dates in the future. This is why the "bonuses" are included in the calculation of net premium reserves. I don't want to call them "bonuses" though because they aren't. They are guaranteed benefits and shouldn't be grouped in with the bonuses definition as confusion can come in (much like in this case).
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