Life Insurance Finance
This domain tests how a life insurer converts long-dated promises into balance-sheet liabilities, regulatory capital and reported profit. Expect reserving bases, new business strain, unit-linked and with-profits treatment, solvency capital and embedded value.
Policy liabilities
Life reserves are computed with prudent mortality, lapse, expense and interest assumptions. A gross premium valuation discounts future benefits and expenses less future premiums; a risk margin is added for non-hedgeable risk. Unit-linked liabilities equal the unit fund, with a non-unit reserve for charges and guarantees. Assets are matched to liabilities by currency and duration.
Capital and strain
Solvency capital (the SCR) must be met by eligible own funds in permitted tiers. Expense reserves must reflect the cost of administering run-off business, including fixed costs. New business usually consumes capital because acquisition costs plus the initial reserve exceed the first premium - new business strain. The strain is released as margins emerge. Reinsurance relieves strain only where genuine risk transfer exists; deposit or financing treaties do not.
Profit
Embedded value equals net asset value plus the present value of future shareholder profits (VIF). Statutory surplus is not the same as EV. With-profits business typically gives policyholders at least 90% of distributed profits, and the inherited estate may be partly attributable to them. Tax treatment differs between policyholder and shareholder funds.
Worked example
A regular-premium policy collects £1,000 at inception. Commission and issue costs are £1,500; the year-end reserve is £1,200. Cash after expenses is −£500, so the insurer funds £500 plus the £1,200 reserve: new business strain is £1,700. That £1,700 is capitalised and released into profit over the term only if experience meets the pricing assumptions.
Traps
- Mixing statutory, GAAP and EV figures.
- Taking reinsurance credit without testing risk transfer.
- Treating the risk margin as available capital.
- Assuming profit is recognised at sale.
- Ignoring the cost of options and guarantees in unit-linked products.