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Why do we assume time 0 reserves are equal to 0?

+1 vote
asked Nov 15, 2017 in BUS 3024S - Contingencies by Kelly (970 points)

Is this a simplifying assumption that is used for all contingencies exams and tests? Or is there a rational explanation? 

I understand that before a policy is sold, no reserves are required. But as the policy is sold, surely one can (and should) set up a reserve, say particularly if we are pricing reserves using zeroization? Furthermore, surely there are regulations which ensure insurance companies hold reserves for consumer protection purposes (and these would include time 0 reserves).

Also, unless premiums are calculated using the equivalence principle and the reserving basis is the same as the premium pricing basis, then surely time 0 reserves are not strictly 0?

Test 2 question 4b is a good example where they've made the tV0=0 assumption. 

1 Answer

+1 vote
answered Nov 15, 2017 by Dean_Bunce (1,160 points)
Best answer

You are right about time 0 reserves being non-zero if the reserving basis is different from the pricing basis.

The regulations are not something that are relevant to Conties (also I don't know what they are, but its the kind of thing that seems sensible).

0 reserves at time 0 tend to come up when the required reserves calculated are negative at time 0 i.e. the company can release an immediate profit. This is not prudent so is not generally done. Also if there are negative reserves at the beginning it is likely that reserves are going to be required later on. So instead of releasing profits at the beginning we take 0 profits and reduce the reserves that will be needed later on.